Principles of Business Taxation ‘Finance Act 2006’ Thispageintentionallyleftblank
Principles of Business Taxation ‘Finance Act 2006’
Chris Jones, BA CTA (Fellow) ATT
Amst er dam Bost on Heidelber g London New Yor k Oxf or d Par is San Diego San Fr ancisco Singapore Sydney Tokyo
Elsevier But t er wor t h-Heinemann Linacr e House, J or dan Hill, Oxf or d OX2 8DP 30 Cor por at e Dr ive, Bur lingt on, MA 01803
First published 2007
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CONTENTS
Preface ix
A: Introduction to the UK Tax System 1
B: Computation of Taxable Trading Profit 7
B1: Tr ading I ncome and t he Badges of Tr ade 7 B2: Adj ust ment of Prof it 14
B3: Capit al V Revenue 23 B4: Capit al Allowances – Def init ion 30 B5: Capit al Allowances – Comput at ion 37 B6: I ndust r ial Buildings Allowances 47 B7: I nt angible Fixed Asset s 64 B8: Resear ch and Development Expendit ur e 73 B9: Tax Law and Account ing Pract ice 84
C: Taxation of Limited Companies 91
C1: Comput at ion of Cor por at ion Tax 91 C2: Associat ed Companies 102 C3: Shor t Account ing Per iods 110 C4: Long Per iods of Account 116 C5: Cor por at ion Tax Self Assessment (CTSA) 125 C6: Payment of Cor por at ion Tax 141 C7: I nt er est on Lat e Paid Tax 151 C8: CTSA Penalt y Regime 156 C9: I ncome f r om Proper t y 161 C10: Loan Relat ionships 167 C11: Relief f or Tr ading Losses 177 C12: Relief f or Ot her Losses 187 C13: Cor por at e Capit al Gains 192 C14: Rollover Relief 201 C15: Shar es and Secur it ies: Mat ching Rules 208 C16: Subst ant ial Shar eholding Exempt ion 223 C17: The Principles of Group Relief 228 C18: Group Capit al Gains 241 C19: Close Company Def init ion 252 vi Cont ent s
C20a: Close Company I mplicat ions – Par t 1 261 C20b: Close Company I mplicat ions – Par t 2 266 C21: I nvest ment Companies 271 C22: Cor por at e Vent ur ing Scheme 279
D: Employee Tax Matters 288
D1: Employed or Self Employed? 288 D2: I nt r oduct ion t o Employment I ncome & Benef it s 295 D3: Company Car & Fuel Benef it s 308 D4: Living Accommodat ion – Taxable Benef it s 318 D5: Loans t o Employees & Use of Asset s 325 D6: Miscellaneous Benef it s 335 D7: Expenses of Employment 343 D8: Calculat ing t he I ncome Tax Liabilit y 353 D9: I nt r oduct ion t o PAYE 360 D10: PAYE End of Year Ret ur ns 369 D11: Class 1 Nat ional I nsur ance Cont r ibut ions 376 D12: Class 1A and 1B Nat ional I nsur ance Cont r ibut ions 388 D13: Ter minat ion Payment s 396 D14a: Occupat ional Pensions and Fur bs 408 D14b: The Ent er pr ise I nvest ment Scheme 417
E: Value Added Tax 423
E1: Over view of t he VAT Syst em 423 E2: Regist r at ion 432 E3: Def init ion of Supplies 444 E4: Liabilit y of t he Supply 451 E5: Schedule 8 VATA 1994 – Zer o Rat ing 455 E6: Schedule 9 VATA 1994 – Exempt ions 463 E7: Deemed Supplies 470 E8: Value of t he Supply 481 E9: Time of Supply 489 E10a: I nput Tax: When t o Recover 496 E10b: Par t ial Exempt ion 511 E11: VAT Recor ds and Ret ur ns 527 E12: Account ing f or VAT 539 E13: Bad Debt Relief 551 E14: Cont r ol Visit s, Appeals and Assessment s 559 E15a: Misdeclar at ion Penalt y 571 Cont ent s vii
E15b: Lat e Regist r at ion Penalt y 577 E15c: Def ault Sur char ge 583 E15d: Repeat ed Misdeclar at ion Penalt y 590 E15e: Ot her Penalt ies, I nt er est and Mit igat ion 596 E16: Ref unds, Repayment Supplement and I nt er est 611
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PREFACE
This book pr ovides all t he mat er ial you need f or t he CI MA Prof essional Development Certificate in Business Taxation. Within each chapter you will find some examples for you t o try, t o t est you on t he impor t ant r ules cover ed in t he chapt er .
At t he end of each chapt er , t her e is a short summar y which cont ains a “pocket digest ” of t he r ules cover ed wit hin t he chapt er . These individual summar ies f or m a compr ehensive over view of t he syllabus.
As t his manual has been wr it t en specif ically t o cover all ar eas of t he syllabus we ar e conf ident you will f ind t his an invaluable t ool leading t o success in t he examinat ion. Thispageintentionallyleftblank
CIMA TAX TABLES
Income Tax rates 2006-07 2005-06 % % Starting rate 10 10 Basic rate 22 22 Higher rate 40 40 £ £ Starting rate band 1 - 2,150 1 - 2,090 Basic rate band 2,151 - 33,300 2,091 - 32,400
Income Tax reliefs 2006-07 2005-06 £ £ Personal allowance 5,035 4,895
Income Tax – Pension contributions Annual Lifetime allowance allowance £ £ 2006-07 215,000 1,500,000 2007-08 225,000 1,600,000 2008-09 235,000 1,650,000 2009-10 245,000 1,750,000 2010-11 255,000 1,800,000 Basic amount qualifying for tax relief £3,600
Company cars and fuel Company cars Cash equivalent 15% of list price for cars emitting 140g/km Increased by 1% per 5g/km over the 140g/km limit Capped at 35% of list price 3% supplement on diesel cars not meeting the Euro IV emission standards or registered after 1 January 2006 (subject to 35% cap)
Van scale charge £500 (reduced to £350 if more than four years old at the end of the fiscal year). There is no taxable benefit where an employee takes a van home but is not allowed any other private use.
Fuel scale benefits For 2006-07 (& 2005-06) the benefit is £14,400 multiplied by the percentage used in calculating the car benefit (i.e. based on carbon dioxide emission rating). xii CI MA Tax Tables
Small and medium sized enterprise limits Small Medium (i) Turnover £5.6m £22.8m (ii) Balance sheet assets £2.8m £11.4m (iii) Employees 50 250
Corporation Tax Financial year 2006 2005 Full rate 30% 30% Small companies' rate 19% 19% Starting rate – 0% Profit limit for lower rate – £10,000 Profit limit for lower rate marginal relief – £50,000 Profit limit for small companies' rate £300,000 £300,000 Profit limit for small companies' marginal relief £1,500,000 £1,500,000 Marginal relief fraction for profits between £10,000 and £50,000 – 19/400 Marginal relief fraction for profits between £300,000 and £1,500,000 11/400 11/400
For FY 2005 there is a minimum corporation tax charge of 19% on PCTCT distributed to non corporate shareholders. This does not apply for FY 2006.
Research and Development expenditure and transfer pricing: small and medium sixed company limits Medium Small Employees 250 50 Turnover ε50m ε10 million Balance sheet assets ε43m ε10 million
National Insurance Contributions 2006-07 2005-06 Class 1 contributions Annual Weekly Annual Weekly Lower earnings limit £4,368 £84 £4,264 £82 Earnings threshold £5,035 £97 £4,895 £94 Upper earnings limit £33,540 £645 £32,760 £630
Employee’s contributions in 2006-07 (2005-06) Not contracted out: 11% (11%) on earnings between £97 (£94) and £645 (£630) 1% (1%) above £645 (£630) per week Contracted out: 9.4% (9.4%) on earnings between £97 (£94) and £645 (£630) 1% (1%) on earnings above £645 (£630) per week 1.6% rebate on earnings between £84 (£82) and £97 (£94)
Employer’s contributions in 2006-07 (2005-06) Not contracted out: 12.8% (12.8%) on earnings in excess of £97 (£94) Contracted out: Salary related: 9.3% (9.3%) on earnings between £97 (£94) and £645 (£630) 12.8% (12.8%) on earnings in excess of £645 (£630) 3.5% (3.5%) rebate on earnings between £84 (£82) and £97 (£94) Contracted out: Money purchase: 11.8% (11.8%) on earnings between £97 (£94) and £645 (£630) 12.8% (12.8%) on earnings in excess of £645 (£630) 1% rebate on earnings between £84 (£82) and £97 (£94) CI MA Tax Tables xiii
2006-07 2005-06 Class 1A contributions 12.8% 12.8% Class 1B contributions 12.8% 12.8% Class 2 contributions Normal rate £2.10 pw £2.10 pw Small earnings exception £4,465 pa £4,345 pa Class 3 contributions £7.55 pw £7.35 pw Class 4 contributions Annual lower earnings limit £5,035 £4,895 Annual upper earnings limit £33,540 £32,760 Percentage rate between limits 8% 8% Percentage rate above upper limit 1% 1%
Capital Gains Tax
Retail Prices Index Where Retail Price Indices are required, it should be assumed that they are as follows.
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec 1982 – – 79.44 81.04 81.62 81.85 81.88 81.90 81.85 82.26 82.66 82.51 1983 82.61 82.97 83.12 84.28 84.64 84.84 85.30 85.68 86.06 86.36 86.67 86.89 1984 86.84 87.20 87.48 88.64 88.97 89.20 89.10 89.94 90.11 90.67 90.95 90.87 1985 91.20 91.94 92.80 94.78 95.21 95.41 95.23 95.49 95.44 95.59 95.92 96.05 1986 96.25 96.60 96.73 97.67 97.85 97.79 97.52 97.82 98.30 98.45 99.29 99.62 1987 100.0 100.4 100.6 101.8 101.9 101.9 101.8 102.1 102.4 102.9 103.4 103.3 1988 103.3 103.7 104.1 105.8 106.2 106.6 106.7 107.9 108.4 109.5 110.0 110.3 1989 111.0 111.8 112.3 114.3 115.0 115.4 115.5 115.8 116.6 117.5 118.5 118.8 1990 119.5 120.2 121.4 125.1 126.2 126.7 126.8 128.1 129.3 130.3 130.0 129.9 1991 130.2 130.9 131.4 133.1 133.5 134.1 133.8 134.1 134.6 135.1 135.6 135.7 1992 135.6 136.3 136.7 138.8 139.3 139.3 138.8 138.9 139.4 139.9 139.7 139.2 1993 137.9 138.8 139.3 140.6 141.1 141.0 140.7 141.3 141.9 141.8 141.6 141.9 1994 141.3 142.1 142.5 144.2 144.7 144.7 144.0 144.7 145.0 145.2 145.3 146.0 1995 146.0 146.9 147.5 149.0 149.6 149.8 149.1 149.9 150.6 149.8 149.8 150.7 1996 150.2 150.9 151.5 152.6 152.9 153.0 152.4 153.1 153.8 153.8 153.9 154.4 1997 154.4 155.0 155.4 156.3 156.9 157.5 157.5 158.5 159.3 159.5 159.6 160.0 1998 159.5 160.3 160.8 162.6 163.5 163.4 163.0 163.7 164.4 164.5 164.4 164.4 1999 163.4 163.7 164.1 165.2 165.6 165.6 165.1 165.5 166.2 166.5 166.7 167.3 2000 166.6 167.5 168.4 170.1 170.7 171.1 170.5 170.5 171.7 171.6 172.1 172.2 2001 171.1 172.0 172.2 173.1 174.2 174.4 173.3 174.0 174.6 174.3 173.6 173.4 2002 173.3 173.8 174.5 175.7 176.2 176.2 175.9 176.4 177.6 177.9 178.2 178.5 2003 178.4 179.3 179.9 181.2 181.5 181.3 181.3 181.6 182.5 182.6 182.7 183.5 2004 183.1 183.8 184.6 185.7 186.5 186.8 186.8 187.4 188.1 188.6 189.0 189.9 2005 188.9 189.6 190.5 191.6 192.0 192.2 192.2 192.6 193.1 193.3 193.6 194.1 2006* 193.4 194.2 194.6 195.0 195.4 195.8 196.2 196.6 197.0 197.4 197.8 198.2 2007* 198.6 199.0 199.4 199.8 200.2 200.6 201.0 201.4 201.8 202.2 202.6 203.0
* = assumed
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A: Introduction To The UK Tax System
I n t his chapt er you will cover t he f ollowing ar eas in over view: - t he var ious t axes levied in t he UK; - t he period f or which income t ax is charged; - t he cat egor isat ion of sour ces of income; - t he sour ces of income t hat ar e exempt f r om income t ax.
A1.1 Taxes in the UK
The UK gover nment r aises in t he r egion of 270 t o 280 billion pounds in t axat ion each year .
Income tax is t he single lar gest ear ner f or t he gover nment making up 30% of t ot al r evenue. I ncome t ax is char ged on salar ies f r om employment , on r ent al income f r om pr oper t ies let out , on int er est f r om banks and building societ ies, on dividends f r om companies and on t he pr of it s of t he self employed.
The second lar gest ear ner f or t he gover nment is value added t ax (VAT). This makes up about 23% of t he t ot al gover nment r evenue and is char ged by businesses t o cust omer s on supplies of goods or ser vices in t he UK.
Nat ional I nsur ance cont r ibut ions (NIC) make up 21% of t ot al gover nment income. Nat ional I nsur ance cont r ibut ions ar e gener ally paid by bot h employer s and employees on ear nings f r om employment , alt hough NI C is also levied on self employed per sons on t he pr of it s of t heir t r ade.
I ncome t ax, VAT and NI C are t he t hr ee most impor t ant t axes as f ar as r aising money is concer ned, making up about 75% or so of t ot al gover nment r evenue.
A lar ge par t of t he r emainder (16%), is made up of duties, being t axes on alcohol, pet r ol and t obacco, as well as cer t ain levies on goods coming int o t he UK.
Corporation tax makes up about 8% of t ot al gover nment r evenue, being t he t ax paid by UK companies on t heir t axable pr of it s.
The r emaining slice consist s of t he “capital taxes” being capit al gains t ax (CGT), inher it ance t ax (I HT), st amp dut y (SD) and st amp dut y land t ax (SDLT). Capit al gains t ax is t he t ax levied when individuals sell asset s and make a pr of it .
2 Principles of Business Taxat ion ‘Finance Act 2006’
A1.2 The tax year
I ndividuals pay income t ax by r ef er ence t o t he “t ax year ”. The UK t ax year r uns f r om 6 April to the following 5 April. For example, t he t ax year t hat begins on 6 April 2006 and ends on 5 April 2006 is known as t he t ax year 2006/ 07.
The t ax r at es and t ax allowances f or t he 2006/ 07 t ax year , wer e set in t he March 2006 Budget .
Ther e ar e t wo st ages in calculat ing an individual’s t ax liabilit y. Fir st we comput e t he individual’s t axable income f r om all sour ces in t he r elevant t ax year . Having ar r ived at taxable income we t hen apply t he 2006/ 07 tax rates and allowances t o t hat income, t o ar r ive at t he tax liability f or t he year. This t ax will be collect ed by t he HM Revenue & Cust oms (“t he Revenue”) under t he “self - assessment ” syst em. This will be dealt wit h in a lat er chapt er .
A1.3 Sources of income
The t ax legislat ion cat egor ises var ious sour ces of income. Each t ype of income has it s own special r ules. This is why we need to decide what type of income an individual has r eceived.
When we looked at income r eceived by individuals in t he past , t he types of income wer e sor t ed int o Schedules and somet imes f ur t her divided int o Cases. This was called t he Schedular system. I t st ill oper at es f or companies and so we will be looking at it in det ail when we st udy companies. You may well f ind r ef er ences t o t he old syst em in past quest ions. So we will ment ion t he main point s of t he old syst em as we explain t he cur r ent way of sor t ing out t he t ypes of income.
The f ir st t ype of income t hat we will t hink about is trading income. This cover s pr of it s f r om a t r ade. So, f or inst ance, a self employed per son in business as a t axi dr iver , or a mar ket t r ader , or a builder or plumber , would be t axed on his trading income. This used t o be called Schedule D Case I income.
Tr ading income also cover s pr of it s f r om a pr of ession or vocat ion. For inst ance, a self employed pr of essional such as a solicit or or bar r ist er would also have trading income. This used to be called Schedule D Case II income. Tr ading income is a ver y impor t ant t ype of income and we will deal with it in a separate module.
The second type of income we need to consider is property income. This is income f r om land and buildings, such as rental income. We need t o keep pr oper t y income f r om UK land and buildings separate f rom property income f rom non-UK land and buildings. I ncome f r om UK land and buildings used t o be t axed under Schedule A. I ncome f r om non-UK land and buildings used t o be t axed under Schedule D Case V.
I nt r oduct ion t o t he UK Tax Syst em 3
Next , t her e is a ver y impor t ant t ype of income called income f r om earnings and pensions. Earnings cover s salaries, bonuses and non-cash benefits. We will look at t hese in det ail in lat er sessions. This t ype of income used t o be t axed under Schedule E.
Ther e ar e var ious t ypes of savings and investment income. A ver y common one is int er est ar ising f r om UK banks and building societies. We call t his interest income. This t ype of income used t o be t axed under Schedule D Case III.
Anot her t ype of invest ment income is dividends received from companies. These used t o be t axed under Schedule F. As we will see lat er , dividend income needs to be kept separate from other types of investment income because it has dif f er ent r at es of t ax applied t o it .
These ar e t he t wo main types of savings and invest ment income.
An individual may have income f r om outside the UK. We have alr eady seen t hat he may have property income f r om non-UK land and buildings. He may also have investment income f r om out side t he UK such as non-UK bank interest or non- UK dividends. All income ar ising out side t he UK is now called foreign income. For eign invest ment income used t o be t axed under Schedule D Case V.
I t is impor t ant t o not e her e t hat income can st ill be taxable in t he UK, even if it ar ises f r om a sour ce outside t he UK. As a gener al pr inciple, individuals who live in t he UK and who wer e born in t he UK will pay UK income t ax on t heir worldwide income wher ever it comes f r om. So, a UK resident will gener ally pay income t ax on f or eign income.
Finally, t her e is income which is char geable t o income t ax which does not f all wit hin any of t he cat egor ies t hat we have j ust looked at . This is called miscellaneous income. I t is t he Revenue' s way of cover ing it self and making sur e t hat t axable income doesn' t f all t hr ough t he net . Miscellaneous income used t o be t axed under Schedule D Case VI.
A1.4 Exempt income
Ther e ar e a f ew sour ces of income which ar e specif ically exempt f r om income s. 692 t ax. I ncome f r om National Savings Certificates is exempt f r om t ax, as ar e any I TTOI A winnings on Premium Bonds. Any income f r om betting, gaming or lotteries is 2005 exempt f r om income t ax.
Most social security benefits ar e also exempt f r om income t ax. The not able s.660 except ions t o t his ar e t he st at e pension and any j ob-seeker s allowances. These I TEPA ar e t axable income. 2003
4 Principles of Business Taxat ion ‘Finance Act 2006’
Any statutory redundancy pay r eceived on t he t er minat ion of an employment is s. 309 also exempt f r om income t ax. I TEPA 2003
Scholarship awards ar e exempt , as is any income f r om ISAs (individual savings SI account s). 1998/ 18 70
Example 1
Which of t he f ollowing sour ces of income ar e exempt f r om income t ax:
Taxable Exempt a) I nt er est on Nat ional Savings Account b) Dividend f r om a f or eign company c) Child’s wages f r om a newspaper r ound d) I ncome f r om Nat ional Savings Cer t if icat e e) Housing benef it f) St at e r et ir ement pension
I nt r oduct ion t o t he UK Tax Syst em 5
Answer 1
Taxable Exempt I nt er est on Nat ional Savings Account Dividend f r om a f or eign company Child’s wages f r om a newspaper r ound (not e) I ncome f r om Nat ional Savings Cer t if icat es Housing benef it St at e r et ir ement pension
Not e: Wages ar e t axable as employment income. The f act t hey are paid t o a child is ir r elevant . However , in most inst ances, t he child’s income will be cover ed by Per sonal Allowances so no t ax will be due.
6 Principles of Business Taxat ion ‘Finance Act 2006’
SUMMARY - INTRODUCTION TO THE UK TAX SYSTEM
The main t axes in t he UK ar e income t ax, VAT, NI C, cor por at ion t ax, capit al gains t ax and inher it ance t ax.
I ncome t ax is paid f or a t ax year which runs f rom 6 April t o 5 April.
I ncome is cat egor ised int o t he f ollowing sour ces:
Tr ading income Proper t y income - UK - non-UK Employment income Savings and invest ment income - int er est income - dividend income For eign income Miscellaneous income
Some income is exempt f rom income t ax such as:
I ncome f r om Nat ional Savings Cer t if icat es Premium bonds winnings I ncome f r om Bet t ing and Lot t er ies Most social secur it y benef it s St at ut or y r edundancy pay I ncome f r om I SAs
B: Computation of Taxable Trading Profit
B1: TRADING INCOME AND THE BADGES OF TRADE
I n t his chapt er we will look at t r ading income including: - t he schedule f or t axing t r ading income; - t he def init ion of a t r ade; - t he “badges of t r ade” ar ising f r om case law; - land t r ansact ions; - t he ant i-avoidance pr ovisions; - whet her r eceipt s ar e t axable or not .
St at ut or y r ef er ences ar e t o I TTOI A 2005 unless st at ed ot her wise.
B1.1 Trading Income
The cat egor y “t r ading income” encompasses bot h income from a trade, for example plumbing or building and income from a profession or vocation. A pr of ession would include account ancy or law. A vocat ion includes act ing, ballet dancing, t heat r ical per f or ming, spor t et c.
Previously, under t he old schedular syst em income from a trade was t axed under Schedule D Case I , wher eas income f r om a pr of ession or vocat ion was t axed under Schedule D Case I I . Ther e wer e no not able dif f er ences bet ween t he way pr of it s wer e taxed under DI or DI I .
B1.2 The definition of trading
I ncome t ax is char ged on “t he pr of it s of a t r ade, pr of ession or vocat ion”. s. 5
A t r ade is def ined as ”ever y manuf act ur e, advent ur e or concer n in t he nat ur e of t r ade”.
A “t r ade” is def ined in t he legislat ion as a “t r ade”, which is a cir cular def init ion and does not t ake us a gr eat deal f ur t her . Ther ef or e, t he int er pr et at ion of what is meant by t he t er m “t r ade” has been lef t lar gely t o t he Cour t s. The Cour t s have developed a number of t est s t o det er mine whet her somebody is t r ading. These t est s ar e known as t he “badges of t r ade”.
B1.3 The Badges of Trade
Prof it seeking mot ive
When a per son ent er s int o a t r ansact ion, we need t o ident if y whet her t her e is a pr of it seeking mot ive. I t is not t he exist ence of a pr of it t hat is impor t ant , it is t he mot ive t o ear n one. However HM Revenue and Cust oms (t he Revenue) will r eally be int er est ed in t his issue if a pr of it has act ually been ear ned, because t hen t hey have somet hing t o t ax. 8 Principles of Business Taxat ion ‘Finance Act 2006’
A t axpayer may ar gue t hat t hey ar e t r ading in or der t o ut ilise a loss t o r educe t heir t ax bill. The t axpayer must demonst r at e t he mot ive r at her t han t he exist ence of pr of it t o est ablish t hat a t r ade is being car r ied on.
Fr equency and number of similar t r ansact ions
I f we do somet hing once, never t o be r epeat ed again, it is unlikely t hat we would be t r eat ed as car r ying on a t r ade. However if we keep doing it , it is mor e likely t hat we ar e t r ading. For inst ance, assume I sold my car which I had owned f or f our year s. I t hen bought myself anot her car and sold t hat one t wo year s lat er . I t is unlikely t he Revenue would consider t hat I am t r ading in car s. I f , however , I bought and sold car s ever y mont h, it is more likely t hat t hey will seek t o t ax t he pr of it s as t r ading income.
The most not able case in t his ar ea is Pickf ord v Quirke wher e a t axpayer pur chased a mill wit h t he obj ect of using it f or t r ading pur poses. However it t ur ned out t hat t he mill was in a much wor se st at e t han t hey had imagined and t he best t hing t he t axpayer could do was t o st r ip all t he it ems out of it and sell t hem piecemeal. He made a consider able pr of it doing t his, so he did it again and again and again. As a r esult of t he r epeat ed number of t r ansact ions, it was held t hat t he pr of it s wer e t axable as t r ading income.
I f we buy somet hing, do not hing t o it t hen sell it , it is unlikely we ar e t r ading. However , if we bought a car , put a new engine in it , r espr ayed t he body and made it mor e at t r act ive t o buy, it is possible we would be consider ed t o be t r ading.
Nat ur e of t he asset
We cannot pin a t r ading label ont o a single one-of f t r ansact ion simply because we cannot j ust if y t hat t he par t icular asset was pur chased f or any ot her pur pose t han t o r esell it . The most not able case in t his ar ea is Rut ledge v CI R.
I n t his case, a t axpayer pur chased 1 million r olls of t oilet paper in one single t r ansact ion. He then sold them on at a profit in another single transaction. This was held to be t r ading (an “advent ur e” in t he nat ur e of t r ade) as t her e was no ot her j ust if iable r eason t o pur chase such a lar ge quant it y of t oilet paper - he could not ar gue t hat t his was simply over st ocking!
Connect ion wit h an exist ing t r ade
Taking an example of a car , let us say t hat as a t ax account ant I sell a car. I t is unlikely t hat I would be t rading in cars because t here is no link bet ween selling cars and being a t ax account ant . I f however I was a car mechanic who occasionally sold a car , t he Revenue ar e much mor e likely t o successf ully t ax t he pr of it s on t he sale of car s along wit h my exist ing t r ade as t her e is a dir ect link bet ween r epair ing car s and selling car s. Ot her badges of t r ade would also need t o apply, but such a link is somet hing t hat t he Revenue will look ver y closely at . Tr ading I ncome and t he Badges of Tr ade 9
Financing ar r angement s
I f an asset is pur chased on a shor t t er m loan which t he t axpayer is unable t o f und wit hout selling t he asset again, t hen t he Revenue can successf ully ar gue t hat t he asset was pur chased specif ically wit h a view t o selling it .
This was cit ed in t he case of Wisdom v Chamber lain wher e t he comedian Nor man Wisdom bought a mound of silver bullion on a short t erm loan. He could not service t he int er est payment s f r om his exist ing money, but as soon as he sold t he bullion and r epaid t he loan he f ound he had made a subst ant ial pr of it . This pr of it was t axed as t r ading income.
Lengt h of owner ship
I f you have owned somet hing f or a long t ime, it is much easier t o j ust if y t hat you bought it f or it s enj oyment or f or your own pr ivat e consumpt ion. A pr of it on sale would not t her ef or e be t r eat ed as a t r ading pr of it . I f however you have only owned it f or a shor t period it is much more likely that the Revenue could successfully argue that it was pur chased wit h t he aim of selling it at a pr of it .
The exist ence of a sales or ganisat ion
I n t he case of The Cape Br andy Syndicat e, a syndicat e of char t er ed account ant s dist illed brandy. They dist illed f ar mor e t han t hey could act ually dr ink t hemselves and sold t he sur plus. The Revenue sought t o t ax t hem as t r ading income. They ar gued t hat t hey wer e simply selling what t hey could not physically dr ink t hemselves. However as t hey had set up a special phone line and inf or mat ion desk and published br ochur es and adver t s adver t ising t heir br andy, t he Revenue successf ully ar gued t hat t hey had commenced a t r ade.
Reason f or t he acquisit ion/ sale
Finally, we will look at how t he asset was acquir ed – ie, whet her pur chased or ot her wise acquir ed by gif t or inher it ance - and what is t he r eason f or t he sale of t he asset ? By way of an example, consider Maud who inher it s a war dr obe f ull of f ur coat s f r om her lat e mot her . She does not want t o wear t hem, so she put s an adver t in t he local paper t o sell t hem. The Revenue spot t his adver t and seek t o t ax Maud f or any pr of it s ear ned. As Maud inherit ed t he coat s it is highly unlikely t hat a t r ading label can be pinned t o t hese t r ansact ions. However if Maud had pur chased a war dr obe f ull of f ur coat s, adver t ised t hem and t hen sold t hem at a pr of it , it is much mor e likely t hat she would be held t o be t r ading. Simply r ealising an inher it ance f or cash is not t he commencement of a t r ade.
I n some cir cumst ances, t he exist ence of one single badge is enough t o show t r ading (as in t he case of Rut ledge v CI R). However in ot her cases we need t o look at a combinat ion of t he badges of t r ade. The t r igger t o get t he Revenue int er est ed in t he t r ansact ion in t he f ir st place is t he exist ence of a pr of it .
10 Principles of Business Taxat ion ‘Finance Act 2006’
B1.4 Land transactions
The Revenue of t en look closely at t he pur chase and sale of land and buildings, simply due t o t he size of t he pr of it s involved. I t is in t he ar ea of land t r ansact ions t hat t he most cases involving t he badges of t r ade have been t aken t o t he Cour t s.
One of t he impor t ant quest ions t o ask is whet her t he t axpayer is “invest ing in land” or “dealing in land” – “dealing” is t r ading. This quest ion which was posed in t he case of Mar son v Mor t on. Here a t axpayer purchased some land wit h t he int ent ion of holding on t o it as an invest ment f or at least t wo year s. I n or der t o incr ease t he value of t he land, t he t axpayer applied f or planning per mission. Looking at t he badges of t r ade, t his will be r egar ded by t he Revenue as a modif icat ion t o an asset t o make it mor e saleable.
It was held in this case that because the or iginal int ent ion was t he pur chase of an invest ment , no t r ade was being car r ied on. I t is not what t he t axpayer says which det er mines int ent ions, it is what t he sur r ounding evidence suppor t s. Document ed int ent ions made t he dif f er ence.
Anot her quest ion t hat we must ask is, is whet her our t axpayer is a r esident in t he pr oper t y, or a developer who is r ef ur bishing a pr oper t y f or onwar d sale. I n t he case of Kir kby v Hughes, a builder pur chased a r un-down house. He car r ied out a lot of r epair and r ef ur bishment wor k and sold t he house at a healt hy pr of it . He t hen pur chased a st r ip of land and built a house on it , again selling it at a subst ant ial pr of it . He t hen pur chased a bar n and conver t ed it int o a house.
The Cour t s believed t hat he was t r ading because t hey could apply enough of t he badges of t r ade t o him. Ther e clear ly was a pr of it seeking mot ive, he had modif ied t he asset s he pur chased, t her e was a connect ion wit h an exist ing t r ade, and t he lengt h of ownership in each case was f airly short . The prof it s on t he f irst house were held t o be t axable as t r ading income along wit h all of t he ot her pr oper t ies he had bought and sold.
Looking specif ically at one of t he badges of t r ade we should also ident if y a r eason f or t he pur chase and a r eason f or t he sale. I n t he case of Taylor v Good, a husband pur chased a pr oper t y t o be used as a f amily home. However on seeing t he house, his wif e ref used t o live in it . As a result he had no option but t o sell t he house. Despit e it being a one-of f t r ansact ion, t he Revenue f elt t hat t he badges of t r ade applied because t he asset was only owned f or a ver y shor t per iod of t ime. However , t her e was clear ly anot her r eason f or t he acquisit ion and subsequent sale – t her e was a genuine int ent ion by t he t axpayer t o live in t he house r at her t han simply t o make a quick pr of it . Ther ef or e t he t r ansact ion was held not t o be a t r ading t r ansact ion.
B1.5 Frequency of transactions
Michael buys unpr of it able r est aur ant s, t ur ns t he businesses ar ound and sells t hem at a profit. He has done this 12 times. The idea came to him when he sold his first r est aur ant which he had r un as t he owner and manager f or 10 year s. Tr ading I ncome and t he Badges of Tr ade 11
The quest ion we ar e asking is whet her he is char geable t o t ax on t rading income, f ir st in r espect of t he r est aur ant s in gener al, which he had r un f or a shor t per iod, but also in r espect of t he f ir st r est aur ant which he had r un f or a long per iod.
We must look closely at t he badges of t r ade. Clear ly t her e is a pr of it seeking mot ive which is readily ident if iable. The f requency of t r ansact ions which Michael is under t aking point s t owar ds a t r ade. Modif icat ions t o t he asset pur chased (t aking an unpr of it able r est aur ant and t ur ning it ar ound), t he lengt h of owner ship (he owns t hem f or a r elat ively shor t per iod of t ime) and t he r eason f or t he sale (t o make money), lead us t o dr aw t he conclusion t hat t hese t r ansact ions will clear ly be t r ading t r ansact ions.
The next quest ion is – do t he f ut ur e t r ansact ions t aint t he f ir st one? Unf or t unat ely t he answer t o t his quest ion is yes. I n t he case of Leach v Pogson, an individual had owned a driving school for a long period of time before he sold it at a profit. He then pur chased, t ur ned ar ound and sold numer ous ot her dr iving schools in t he f ut ur e. I t was held by t he Cour t s t hat not only wer e pr ofit s f r om sales of t he lat er dr iving schools char ged t o t ax as t r ading income, but t he or iginal disposal, alt hough or iginally t r eat ed as a capit al t r ansact ion, will be t ur ned int o a t r ading t r ansact ion because of lat er event s.
B1.6 Share Dealing
Mur iel t hinks she has an inf allible syst em t o pr edict shar e pr ice movement s. Over a t wo year per iod she ent er ed int o over 100 t r ansact ions buying and selling shar es. She made a pr of it on some but over all she made a loss, so her syst em was not as inf allible as she t hought ! Will she manage t o obt ain loss r elief against her gener al income?
I n or der t o set a loss against ot her income, t he loss must be a t r ading loss – we will come t o losses lat er in t his cour se. The quest ion is whet her Mur iel is dealing or invest ing. I n t he case of Salt v Chamber lain it was held t hat all shar e t r ansact ions ar e capit al in t heir nat ur e unless t hey ar e under t aken by a pr oper ly r egist er ed shar e dealer . Ther ef or e if a pr ivat e individual (not a shar e dealer ) buys and sells shar es many many t imes, he can never have t he badges of t r ade pinned on t o t hose t r ansact ions. Such pr of it s will be t axable as capit al gains and subj ect t o CGT wit h all t he advant ages of indexat ion and t aper r elief .
12 Principles of Business Taxat ion ‘Finance Act 2006’
B1.7 Taxable and Non-Taxable Receipts
I f r eceipt s ar e wholly unexpect ed and unsolicit ed, t hey ar e not t axable. This is highlight ed in t he case of Simpson v J ohn Reynolds & Co., in which a t axpayer r eceived a volunt ar y payment f r om an ex-cust omer when t hey wer e asked t o cease t o act as t heir insur ance br oker . Because t he payment was not invoiced, not expect ed and was pur ely an unsolicit ed gif t , it was not held t o be par t of t he t axable t r ading income.
I n Mur r ay v Goodhews, an ex-gr at ia payment given t o a pub landlor d as a r esult of t he cancellat ion of his pub t enancy was held not t o be t axable. The r eason f or t his was t hat t he r eceipt of t he compensat ion had not hing t o do wit h him buying and selling alcoholic dr inks and r unning a pub – it was as a r esult of t he t er minat ion of t he pub t enancy.
However , if amount s ar e expect ed t hen t hey will be t axable. I n t he case of Creed v H & M Levinson Limit ed, a t axpayer was of f er ed an ex-gr at ia amount f r om an ex-cust omer and successf ully sued f or mor e. As t he r eceipt was clear ly solicit ed and expect ed, it was t axable. I n t he case of McGowan v Br own & Cousins, an est at e agent who r eceived compensat ion f or not being appoint ed as let t ing agent , was t axed on t he income as it r elat ed specif ically t o t he t r ade and was solicit ed and expect ed.
Tr ading I ncome and t he Badges of Tr ade 13
SUMMARY - TRADING INCOME AND THE BADGES OF TRADE
Tr ading income encompasses bot h income f r om a t r ade and income f r om a pr of ession or vocat ion.
The st at ut or y def init ion of a t r ade includes t he wor d “t r ade”, so t est s known as t he “badges of t r ade” have developed f r om case law. These include: - pr of it seeking mot ive - f r equency and number of similar t r ansact ions - modif icat ions t o sell an asset - nat ur e of t he asset - connect ion wit h an exist ing t r ade - f inancing ar r angement s - lengt h of owner ship - exist ence of a sales or ganisat ion - how t he asset was acquir ed and t he r eason f or sale.
Land t r ansact ions have f eat ur ed in many cases and t he quest ions t o ask also include: - is t he t axpayer invest ing or dealing? - is t he t axpayer r esident in t he pr oper t y or a developer ?
I f a ser ies of t r ansact ions ar e t r eat ed as t rading t his will t aint t he f irst t ime such a t r ansact ion was car r ied out so it can no longer be r egar ded as a capit al t r ansact ion.
I f a t axpayer has deliber at ely t aken st eps t o t ur n a t r ading t r ansact ion int o a capit al one, t he pr of it s may be t axed as miscellaneous income.
Wholly unexpect ed and unsolicit ed amount s ar e not t axable, however if amount s ar e expect ed t hen t hey will be t axable.
B2: ADJUSTMENT OF PROFIT
I n t his chapt er you will cover t he r ules t hat apply f or adj ust ing account ing pr of it s t o obt ain t he t axable t r ading pr of it s. I n par t icular you will cover : - depr eciat ion; - capit al expendit ur e; - t he wholly and exclusively r ule; - ent er t aining; - gif ts; - luxur y car r ent al payment s.
St at ut or y r ef er ences ar e t o I TTOI A 2005 unless st at ed ot her wise.
B2.1 Introduction
Assume a t r ader pr epar es a set of account s and t hose account s show a pr of it . However , in comput ing t his pr of it t he t rader could have deduct ed expendit ur e which t he Revenue may not like. Consequent ly we ar e r equir ed t o make a number of adj ust ment s in ar r iving at t he t r ader ’s t axable pr of it .
We start wit h t he profit per accounts. We t hen add certain disallowed expenditure, and deduct items which are not taxed as trading income.
This gives us t he “t ax adj ust ed pr of it ”, which is accept able t o t he Revenue.
Prof it per account s X Add: Disallowed expendit ur e X Deduct : I t ems not t axed as t r ade pr of it s (X) Tax adj ust ed pr of it X
I t is t his prof it which is t axable as t rading income.
B2.2 Depreciation
Depr eciat ion is not allowed f or t ax pur poses. This is because t her e ar e so many r at es and met hods of depr eciat ion t he Revenue f eel t hat t r ader s will be encour aged t o choose depr eciat ion r at es which maximise t ax r elief .
Instead businesses are able to claim capital allowances (CAs). CAs ar e nor mally given at a r at e of 25% on a r educing balance basis on asset s t hat qualif y as plant and machiner y. CAs ar e cover ed in a lat er chapt er .
Adj ust ment of Prof it 15
B2.3 Items not taxed as Trading Income
Tr ader s might include all of t heir income in t heir account s, but it is only t r ading
income which is t axed as t rade pr of it s. Ther ef or e all other sources of income s.4 are deducted in ar r iving at t he pr of it f igur e. This other income will then be br ought back in t he main income t ax comput at ion and t axed accordingly. Typical examples of non-t r ading income ar e:
• rental income; • interest income; • dividends received; • any sundry miscellaneous income.
Illustration 1
A t r ader has t he f ollowing r esult s;
Profit & Loss Account; £ ’000 Tur nover 850 Cost of sales (400) Gross Prof it 450 Rent al income 50 I nt er est r eceivable 20 Gross pr of it 520 Of f ice expenses (80) Premises expenses (100) Depr eciat ion (60) Profit before tax 280
Tax Computation; £ ’000 Prof it per account s 280 Add: Depreciation 60 Deduct : Rent al income (50) I nt erest (20) Tr ading I ncome 270
It is t his Tr ading I ncome which is br ought int o t he t r ader ’s income t ax comput at ion as ear ned income.
B2.4 Disallowed expenditure
Ther e ar e t hr ee main cat egor ies in t his ar ea.
• Capital expenditure - t his is any expendit ur e which gives an “endur ing s. 33 benef it ” t o t he business. Ther e is a large amount of case law in this area
which we will cover shor t ly.
16 Principles of Business Taxat ion ‘Finance Act 2006’
• Expenditure which has not been incurred “wholly and exclusively” f or the s. 34 pur poses of t he t r ade. Again t her e is a lar ge amount of case law in t his ar ea.
• Specific disallowables given by t ax st at ut e and case law.
We shall examine each of t hese in t ur n.
B2.5 Capital expenditure
The pur chase of capital equipment should be included on a trader’s balance sheet, as t he balance sheet shows all t he f ixed asset s of t he business. These would include: • mot or car s; • pr emises; • ot her equipment (phot ocopier s, comput er s et c).
These it ems ar e eligible for capital allowances or industrial buildings allowances (I BAs) and t hese r ules will be cover ed in lat er chapt er s.
I f t he t rader has included any capital additions in t he Prof it and Loss Account , t hey should be disallowed and added back in ar r iving at t he Tr ading I ncome. Wher e capit al addit ions qualif y as plant or machiner y, capit al allowances will be given inst ead.
We also disallow profits or losses on the sale of assets. Losses on sales of asset s ar e a disallowed expense and should t her ef or e be added back. Prof it s on sales of asset s ar e not t axable as Tr ading I ncome and should t her ef or e be deducted in ar r iving at t r ading pr of it s.
The t r ader may have also incur r ed legal fees on the acquisition of capit al asset s. These ar e disallowed as t hey relate to a capital item. However , legal f ees incur r ed on t he renewal of a short lease are specifically allowed. A short lease in t his cont ext is a lease of less t han 50 year s.
B2.6 Wholly and exclusively
Expenses ar e only deduct ible if t hey ar e incur r ed “wholly and exclusively” f or s. 34 t he pur poses of t he t r ade.
Private expenditure
When pr epar ing account s, t r ader s of t en include it ems which r elat e in whole or in par t t o t heir own pr ivat e af f air s (ie not t o t he business). For example a t r ader may decide t o deduct a “salary” which he pays t o himself out of t he pr of it s of t he business. This “salar y” is not t axable on him as employment income since his pr of it s ar e char ged t o t ax as a self -employed individual (he is not an employee).
Adj ust ment of Prof it 17
Consequent ly we add back any salar y or wages dr awn f r om t he business by t he pr opr iet or in ar r iving at t he t ax adj ust ed pr of it . Salaries paid to employees are allowable as there is a corresponding charge to income tax on the employment income.
Mortgage interest r elat ing t o t he t r ader s pr ivat e r esidence is clear ly a pr ivat e expense and is not incur r ed “wholly and exclusively f or t he pur poses of t he t r ade”. I t should t her ef or e be added back. However , int er est paid on a loan t o buy business premises (shop, of f ice et c) will be allowed as a deduct ion.
Motor expenses ar e a good example of a pr ivat e expendit ur e. Assume a t r ader dr ives a car , and he agr ees wit h t he Revenue t hat t he car is used 70% of the time for business purposes. However , he deduct s all of t he cost s of r unning t he car in his pr of it and loss account (eg, all f uel, r epair s, insur ance, r oad t ax et c). I f 70% of t he cost s are incur r ed f or business pur poses, 30% of the costs must be disallowed as t hey r elat e t o pr ivat e expendit ur e which has not been incur r ed wholly and exclusively f or t he pur poses of t he t rade. 30% of the motor expenses should be added back to the prof it.
Provided t he t axpayer pr oposes a per cent age which r easonably r ef lect s t he pr ivat e element of t he expense, t he Revenue will usually accept it .
The pr ivat e use adj ust ment can apply t o any expenditure. For example, if a t axpayer uses, say, 20% of his house as an of f ice f or t he pur poses of t he t r ade, he will be able t o deduct 20% of t he mort gage int erest in arriving at his t axable prof it . I f he has deduct ed t he f ull amount in his account s, we would need t o add back 80%.
Travel expenses
Ther e has been a lar ge number of cases going bef or e t he Cour t s wit h r egar d t o t he “wholly and exclusively” t est f or t r avel expenses.
I n t he case of Newsom v Rober t son, a self employed bar r ist er claimed t he cost s of travel from his home in Surrey to his Chambers in Cent r al London. The bar r ist er ar gued t hat he wor ked in bot h locat ions – f r om t ime t o t ime he needed t o pr epar e cases and r ead t hr ough client f iles at home. However , he was not list ed in t he t elephone dir ect or y as a bar r ist er at his home addr ess, and he did not want his client s visit ing him at his home. He could have car r ied out his paper wor k in Chamber s, it was j ust t hat he chose t o wor k f r om home. As a r esult , t he Cour t s wer e not satisfied t hat t he t r avel expenses had been incur r ed wholly and exclusively f or t he pur poses of his pr of ession and t her ef or e disallowed t he cost s.
I n Hor t on v Young, a bricklayer worked at a number of different sites. He negot iat ed his cont r act s and kept his r ecords at his home. I n order t o lay bricks he obviously had t o travel to the site at which t he br icks needed laying. Ther ef or e t he Cour t s wer e sat isf ied t hat any t r avel cost s wer e incur r ed wholly and exclusively f or t he pur poses of t he t r ade. The builder ’s fixed place of business was his home, therefore travel costs to the site were allowed.
18 Principles of Business Taxat ion ‘Finance Act 2006’
I n Sar geant v Bar nes, a dent ist t r avelled f r om his home ever y mor ning t o his sur ger y. Cost s of t r avelling f r om home to work are not allowed as a deduct ible expense f or self -employed individuals as t hey ar e not incurred for the purposes of the trade. However , t he dent ist would st op of f at t he lab on his way t o wor k to pick up bits and pieces of equipment he r equir ed t o inser t int o his pat ient s’ mout hs. He t hen dr ove on t o t he sur ger y.
The dent ist ar gued t hat t he cost s of t r avel bet ween t he lab and the surgery wer e allowed, ef f ect ively saying t hat his wor k st ar t ed on r eaching t he lab. However t he Cour t s wer e not sat isf ied t hat t he cost s wer e deduct ible as t he dent ist would have passed t he lab in any event as it was on his nor mal r out e int o t o wor k. Ther ef or e as he did not incur any extra travel costs, t he expenses wer e not deduct ible.
Clothing
I n Mallalieu v Dr ummond, a barrist er claimed t hat t he cost s of her dark Cour t r oom dr ess wer e allowable as an expense against her pr of essional income because she was r equir ed t o wear t hem in Cour t and would not ot her wise wear such clot hing in her ever yday lif e. However t he Cour t s wer e not satisfied that t his was t he case, as t hey ar gued t hat she would be wearing clothing in Court in any event in or der t o pr ovide her wit h warmth and normal decency. The clot hing cost s wer e t her ef or e disallowed as t hey sat isf ied a pr ivat e pur pose.
Ther ef or e, an account ant who only nor mally wear s his suit when he is act ing as an account ant , would not be able t o claim t he cost s of t hat suit as a t r ading expense because he would have t o wear somet hing when meet ing client s.
However , t he Revenue do accept t hat protective clothing (har d hat s, over alls, chef s apr ons et c) is an expense incur r ed wholly and exclusively f or t he pur poses of t he t r ade and will allow such items. The same applies f or act or s’ cost umes.
Children’s wages
I n Dollar & Dollar v Lyon, t he pr ecedent was set t hat wages paid t o t he childr en of t he t r ader ar e only deduct ible pr ovided t hey can sat isf y t he “wholly and exclusively” t est . We t her ef or e need t o demonst r at e t hat if we did not employ our own childr en, we would need t o employ somebody else’s children to perf orm t hose j obs (f or inst ance, wor king in t he shop on a Sat ur day or doing a paper r ound). The wages paid should be at a reasonable market rate, nowadays bear ing in mind t he Nat ional Minimum Wage. I f in t he Revenue’s view t he childr en’s’ wages put t hr ough t he account s ar e simply t heir pocket money (as in t he Dollar & Dollar case), t he cost s would not be deduct ible.
Adj ust ment of Prof it 19
Accountancy fees
I n Smit hs Pot at o Est at es Limit ed v Bolland, t he costs of a tax appeal, even t hough it was successf ul, wer e not allowed as t hey wer e not incur r ed wholly and exclusively f or t he pur poses of t he t r ade. The company had incur r ed t he cost s in its capacity as a taxpayer, not in it s capacit y as a t r ader . Ther ef or e t he cost s did not r elat e specif ically t o it s trade.
Following on f r om t his case, t he Revenue will not accept a deduct ion f or t he cost in pr epar ing an individual’s per sonal t ax r et ur n even t hough t he r et ur n will include det ails of t he Tr ading I ncome. This is because t he cost is being incur r ed in t he individual’s capacit y as a taxpayer, not in his capacit y as a t r ader .
So how do we t r eat account ancy f ees levied f or dealing wit h a tax enquiry? The SP 16/ 91 Revenue has issued a St at ement of Pract ice stat ing that if t he enquir y r elat es specifically to the trading income and as a r esult of t he enquir y no additional profits are brought within the charge to tax, any cost s incur r ed in dealing wit h t hat enquir y will be allowed f or t ax pur poses.
Finance lease assets
The r ule on f inance lease asset s der ives f r om t he case of Gallagher v J ones. SP 3/ 91 Prior t o t his case, many t axpayer s claimed act ual r ent als payable under f inance leases r at her t han t he commer cial char ges which had been put t hr ough t he account s. However in t he case of f inance leased asset s, a deduct ion is given f or the depreciation element together with the interest charge. This is t he only exception to the rule that depreciation is not allowed f or tax purposes. This r ule is r ef er r ed t o in t he Revenue’s St at ement of Pract ice 3/ 91.
B2.7 Specific disallowables
Cost s incur r ed by a t r ader in entertaining anyone except the trader’s own S.45 staff ar e specif ically disallowed by t ax legislat ion.
Gifts of it ems ar e also gener ally disallowed unless; (i) t he asset s gif t ed cost under £50; and (ii) the gif t must bear the business name, logo or a clear advertisement; and (iii) t he gif t should not include food, drink or tobacco.
The Revenue ar e r eluct ant t o give f ull r elief f or t he leasing cost s of luxur y car s. s. 48 A luxury car in t his cont ext is a car cost ing more than £12,000. I n t his inst ance, we only allow r ent al payment s given by t he f or mula below:
Allow: £12,000 + P x Rental payment 2P wher e P = r et ail pr ice of t he car when new
This f ormula can be f ound at s.48(2) I TTOI A 2005.
20 Principles of Business Taxat ion ‘Finance Act 2006’
The luxur y car r est r ict ion does not apply t o t he leasing of car s which:
(i) ar e elect r ically pr opelled; or
(ii) have car bon dioxide emissions less t han or equal t o 120g/ km.
This exempt ion applies t o expendit ur e incurred on or af t er 17 April 2002 on t he hiring of a car which is f irst regist er ed on or af t er t hat dat e.
Example 1
A Mer cedes SLK is leased f or £ 6,000 p.a. The car cost £ 25,000
Calculat e t he amount of t he expense t hat would be allowable and t he amount t hat would be disallowed.
Example 2
St at e whet her t he f ollowing expenses incur r ed by a sole t r ader ar e allowable or disallowable f or t ax pur poses:
Allowable Disallowable
a) Loss on sale of a comput er b) Amor t isat ion of goodwill c) Employee st eals t he pet t y cash d) Ent er t aining t he local vet e) Legal f ees incur r ed on pur chase of a new building f) I nt er est on lat e paid VAT g) Depr eciat ion on a f inance leased asset h) Pur chase of a new washing machine
Adj ust ment of Prof it 21
Answer 1
Allow: £ 12,000 + £ 25,000 x £ 6,000 = £4,440 2 x £ 25,000
Disallow: £ (6,000 – 4,440) = £1,560
i.e. £ 1,560 would be added back in t he adj ust ment t o pr of it s calculat ion.
Answer 2 Allow Disallow
a) Loss on sale of comput er (Capit al) X
b) Amor t isat ion of goodwill (Type of depr eciat ion) X
c) Employee t hef t of cash (Business r isk – wholly and exclusively)
d) Ent er t aining t he local vet (Not staf f ) X
e) Legal f ees on new building (Capit al) X
f ) I nt er est on lat e paid VAT (Fine) X
g) Depr eciat ion on f inance leased (Gallagher v J ones SP3/ 91) asset
h) Pur chase of a new washing (Capit al it em)
machine X
22 Principles of Business Taxat ion ‘Finance Act 2006’
SUMMARY - ADJUSTMENT OF PROFIT
Adjustments must be made to the profit per accounts to arrive at a tax adjusted f igur e.
I t ems not t axed as t r ading income must be deduct ed in ar r iving at t he t ax adj ust ed pr of it and include: r ent al income int er est income dividend income sundr y income pr of it s on sales of f ixed asset s
Disallowed expendit ur e must be added back and includes: - depr eciat ion (except on f inance leased asset s) - capit al expendit ur e - losses on sales of f ixed asset s - legal f ees on acquisit ion of asset s (except r enewal of lease < 50 yrs) - expenses not incur r ed wholly and exclusively f or t he t r ade - pr ivat e expendit ur e - t r avel expenses f r om home t o wor k - nor mal clot hing (but not pr ot ect ive clot hing which is allowable) - childr en’s wages if r eally pocket money - cost s of a t ax appeal - ent er t aining (unless st af f ) - gif t s (unless < £ 50, bear ing t he business name and not f ood, dr ink nor t obacco) - a pr opor t ion of luxur y car r ent als (not “gr een” car s) £ 12,000 + P x Rent al payment (P = r et ail pr ice of new car ) 2P A measur e of r elief f or capit al expendit ur e is available f or t r ader s inst ead of depr eciat ion. Cer t ain it ems will be eligible f or capit al allowances or indust r ial buildings allowances (cover ed lat er ).
B3: CAPITAL v REVENUE
I n t his chapt er we shall look mor e closely at t he r ules f or dist inguishing whet her expendit ur e is capit al in nat ur e (and t her ef or e disallowable) or r evenue in nat ur e and hence would not lead t o any adj ust ment t o pr of it s. You will lear n about : - t he gener al pr inciples; - init ial r epair s; - r epair s v r eplacement s; - st af f cost s; - t r aining cost s; - one-of f cost s
St at ut or y r ef er ences ar e t o I TTOI A 2005 unless st at ed ot her wise.
B3.1 General Principles
Sect ion 33 I TTOI A 2005 disallows any sum employed as capital in t he s. 33 business. This would include it ems such as loan repayments. I f f or inst ance, a t axpayer bor r ows money t o pur chase a business pr emises, any r epayment s he makes back t o t he bank r elat ing t o t he capit al of t he loan will not be t ax deduct ible. However any int er est element will be allowable.
The cost of capital acquisitions is also disallowed. A capit al acquisit ion f or t hese pur poses is any expense which gives an enduring benefit t o t he business.
The cost of improvements t o business pr emises is disallowed. The r eplacement of a par t of t he pr emises wit h t he near est moder n equivalent , r ef lect ing t echnological impr ovement s, is allowable. However , if an it em is subst ant ially upgr aded, t he whole expendit ur e may be capit al.
Specif ically t he Revenue now accept s t hat r eplacing single glazed windows by double glazed equivalent s count s as a r epair . The Revenue’s pr evious view was t hat such expendit ur e would ‘nor mally’ be an impr ovement and t her ef or e disallowed.
B3.2 Initial repairs
I f a t r ader pur chases an asset and t hen spends money on it , is t his expense capit al? I n Law Shipping Company v I RC, a company pur chased a ship which needed some immediat e r epair wor k as it did not possess a cer t if icat e of sea- wor t hiness. They spent t he money and claimed t he r epair s as a r evenue expense in t he pr of it and loss account . However , t he Cour t s held t hat t he r epair s wer e par t and par cel of t he acquisition costs of t he asset as t hey enabled the ship to be used for the very first time. As a r esult , t hese “r epair s” wer e held to be capital – i.e. linked t o t he capit al acquisit ion of t he ship.
24 Principles of Business Taxat ion ‘Finance Act 2006’
Could we ar gue t hat t he cost s ar e r evenue? I n t he case of Odeon Associat ed Theat r es Limit ed v J ones, a number of cinemas wer e pur chased j ust af t er t he war in a ver y r un down st at e. However , Odeon kept t hem open t o t he public and continued to show films. Over a period of time they gradually repaired and r enovat ed t he cinemas and br ought t hem up t o a much smar t er st at e. As much of r epair wor k r elat ed t o dilapidat ions ar ising pr ior t o Odeon’s pur chase, t he Revenue ar gued under t he Law Shipping pr ecedent t hat t he r epair s expenses wer e par t and par cel of t he acquisit ion cost – ie, t hey wer e capit al. However , as the repairs took place to useable assets, t he Court held t hat t he costs were revenue in nature and therefore allowable. The most impor t ant f act or wit h r egar d t o r epair s on newly acquir ed asset s, is whet her t he asset was purchased in a useable state and was actually used in t hat st at e.
B3.3 Repair v Replacement
A repair t o an it em is nor mally allowed as a revenue expense wher eas replacing an ent ir e it em is nor mally consider ed a capital acquisit ion. Ther e ar e t wo cont r ast ing cases her e. I n Bullcr of t Main Collier ies v O’Grady, a business owned a f act or y. On t he same sit e t her e was a f r eest anding chimney. The chimney was in a poor st at e of r epair and t he most economic t hing t o do was t o knock it down complet ely and r ebuild it . This was held t o be a replacement of an entire asset and capital in nat ur e – i.e. a capit al acquisit ion of a br and new chimney.
However , in Samuel J ones & Co (Devondale Lt d) v CI R, a company owned a f act ory which had a chimney act ually at t ached t o it . The chimney was demolished and r eplaced wit h anot her one. The t axpayer successf ully ar gued t hat t his was a repair to a subsidiary part of the factory and not t he r eplacement of an ent ir e asset . The cost s wer e revenue in nat ur e and t her ef or e allowable.
Ther ef or e as f ar as r epair s ar e concer ned, if a t r ader act ually r epair ing a part of an asset , t hat is a genuine repair and t he cost s will be allowed. However, if a t r ader is r eplacing an asset in it s entirety, t hat is a capit al it em.
B3.4 Staff costs
St af f cost s ar e gener ally a revenue expense unless they relate to a capital project. For example, if a f ir m of builder s employs it s own st af f t o const r uct a new head of f ice, we would capit alise t hose par t icular st af f cost s on t he balance sheet as they are part of the acquisition costs of the new head of f ice (the new of f ice being a capit al asset employed in t he business).
Anot her example would be a f ir m of account ant s employing st af f who have developed a new int er nal account ing sof t war e package t o be used long-t er m in t he business. The st af f cost s her e ar e likely t o be linked t o a capit al t r ansact ion and t hey should be disallowed. Capit al allowances should inst ead be claimed on t he sof t war e development cost s. We will deal wit h capit al allowances in a lat er session.
Capit al v Revenue 25
I n I RC v The New Zealand For est I nst it ut e Limit ed, t he company pur chased a number of research undert akings f rom t he New Zealand Gover nment . When t he under t akings wer e pur chased, t he company t ook over all of t he employees’ cont r act s of employment . Some of t he st af f wer e ent it led t o accr ued holiday pay, which was duly paid by t he company who claimed it as a r evenue expense. However , t he Privy Council held t hat t his was capital, r elying on t he decision of Law Shipping. The holiday pay f or med par t of t he acquisition costs of the undertakings, and wer e cont r act ual obligat ions. The company had pur chased an asset (t he new r esear ch under t akings) and wer e immediat ely r equir ed t o spend money on it . That is a capit al t r ansact ion.
J ames Snook & Co Limit ed v Blasdale involved a company owned by a number of dir ect or s. The dir ect or s wer e also shar eholder s. The buyer was pur chasing t he shar es in t he company in r et ur n f or a cash payment t o t he shar eholder s.
The acquisit ion of shar es is nor mally t r eat ed as a capit al t r ansact ion and t he pur chaser would t her ef or e not be able t o obt ain t ax r elief in ar r iving at t heir t axable pr of it s. However , t wo of t he boar d dir ect or s (who wer e also shar eholder s) wer e t o be made r edundant as well as selling t heir shar es.
The pur chaser negot iat ed wit h t hese t wo member s t hat t he cash t hey r eceive would be t r eat ed as compensation for loss of office. This way t he pur chaser could t r eat t he payment as par t of staff costs (ie, as an allowable r evenue expense). However , t he Cour t s did not agr ee. The t r ansact ion was t r eat ed as capit al as t her e was a direct link between the cash and the sale of shares. The Revenue will t r y t o link a payment t o a capit al t r ansact ion wher ever possible. I n t his sit uat ion, it would have been bet t er f or t he pur chaser t o buy t he shar es (at a discount ed pr ice), keep t he boar d member s on f or , say, 6 mont hs, t hen make t hem r edundant . The r edundancy payment in t his inst ance payment would most likely be t r eat ed as a r evenue expense.
B3.5 Training costs
The acquisit ion of new exper t ise is t r eat ed as capit al. For example, assume an individual want s t o t r ade as an account ant . The cost s incur r ed by t hat individual t o acquir e t he r elevant exper t ise and pass t he account ancy exams will not be t r eat ed as an expense in ar r iving at his t axable prof it but will simply be a cost incurred to enable him to trade in t he f irst place.
I n a similar sit uat ion, t he cost s incur r ed by an individual put t ing t hemselves t hr ough t r aining t o become a dr iving inst r uct or would also be treated as capital as t hese ar e cost s t o put t hat per son in t he position to trade, and ar e not incur r ed as part of actually trading.
Ongoing, update or development training, once qualif ied, will be allowed as a r evenue expense because t her e is a dir ect link bet ween t he expense being incur r ed and t he income being r eceived as an account ant or dr iving inst r uct or .
26 Principles of Business Taxat ion ‘Finance Act 2006’
Staff training costs are always allowable as a t r ading expense whet her t his is f or t he st af f t o acquir e new exper t ise or simply keep up t o dat e. I n addit ion, such t r aining is a t ax f r ee benef it f or t hose member s of st af f because t he Gover nment is keen t o encour age employer s t o t r ain and impr ove t heir employees.
B3.6 One-off costs
A one-of f payment may eit her be capit al or r evenue, depending on t he nat ur e of it . A one-of f payment will be capit al if it result s in t he purchase of either a tangible or an intangible asset. An example of an intangible asset would be somet hing like a licence agr eement or a patent royalty. This was given in the case of Mor gan Crucible Company Limit ed v I RC.
I f t he payment affects the value of a capital asset it will also be treated as capit al as decided t he case of Tucker v Granada Mot or way Ser vices Limit ed. Her e a payment t o r educe f ut ur e r ent als on a lease was held t o be capit al in nat ur e because it increased the value of the lease on t he balance sheet .
A one-of f payment will be r evenue (and allowable) if it is made to reduce future revenue obligations and does not r esult in eit her t he acquisit ion or t he incr ease in value of a capit al asset . This was given in t he case of Hancock v The Gener al Rever sionar y and I nvest ment Co Limit ed.
Capit al v Revenue 27
Example 1
You ar e r equir ed t o st at e which of t he f ollowing ar e r evenue or capit al it ems f or t ax pur poses.
Capit al Revenue
a) Replacement of a phot ocopier b) New r oller s on a phot ocopier c) Repair s t o a second hand phot ocopier t o enable it t o be used. d) Redecor at ion of a new of f ice building in line wit h t he business’s “cor por at e image”. e) Redundancy payment s made t o st af f as a r esult of t he t akeover of t he company f) Redundancy payment s made t o a dir ect or / shar eholder as a r esult of a t akeover . g) CPE t r aining f or a self -employed account ant . h) A one-of f payment t o r educe r ent al payment s on a leased building. i) Purchase of an annuity to enable a business t o make pension payment s t o r et ir ed st af f .
28 Principles of Business Taxat ion ‘Finance Act 2006’
Answer 1
Capit al Revenue
a) Replacement of a phot ocopier b) New r oller s on a phot ocopier c) Repair s t o a second hand phot ocopier t o enable it t o be used. d) Redecor at ion of a new of f ice building in (see line wit h t he business’s “cor por at e image”. Not e) e) Redundancy payment s made t o st af f as a r esult of t he t akeover of t he company f) Redundancy payment s made t o a dir ect or / shar eholder as a r esult of a t akeover . g) CPE t r aining f or a self -employed account ant . h) A one-of f payment t o r educe r ent al payment s on a leased building. i) Purchase of an annuity to enable a business t o make pension payment s t o r et ir ed st af f .
Not e:
We will assume t hat t he t r ader pur chased a useable of f ice block, and t her ef or e it is likely we could t r eat t his as a r evenue expense given t he Odeon decision. However we might end up wit h a bat t le f r om t he Revenue if t hey could ar gue t hat t he asset was act ually unusable - i.e. because t he walls wer e not decor at ed in t he cor por at e ident it y. Capit al v Revenue 29
SUMMARY - CAPITAL v REVENUE
I f expendit ur e is capit al in nat ur e it must be disallowed f or t ax pur poses. Capit al acquisit ions giving an endur ing benef it t o t he t r ade and impr ovement s t o business premises must be disallowed. Loan repayments must also be added back although int er est is allowable.
I nit ial r epair s t o an asset t o enable it t o be used ar e disallowed. However init ial r epair s t o a useable asset ar e allowable.
Repair s t o a subsidiar y par t of an asset ar e allowable but r eplacement of an ent ir e asset is capit al expendit ur e. Replacing single glazed windows wit h double glazed equivalent s count s as a r epair .
St af f cost s ar e allowable unless t hey r elat e t o a capit al pr oj ect .
I f on t akeover of a company a cash payment is made t o shareholder s being made r edundant t his will be linked t o t he sale of t he shar es and will be disallowed.
Tr aining cost s t o enable an individual t o t rade will be disallowed alt hough CPE and st af f t r aining cost s ar e allowable.
A one-of f payment t o pur chase an int angible asset is also disallowable, as ar e payment s t hat af f ect t he value of a capit al asset .
B4: CAPITAL ALLOWANCES – DEFINITION
I n t his chapt er you will cover t he r ules f or det er mining whet her plant and machiner y qualif y f or capit al allowances – t he t ax deduction available inst ead of depr eciat ion. You will lear n about : - t he st at ut or y def init ion of non-qualif ying expendit ur e; - t he exclusion f or buildings; - t he exclusion f or st r uct ur es and land; - t he over r ide t o t he exclusions; - case law t est of f unct ion v set t ing.
St at ut or y r ef er ences in t his chapt er ar e t o CAA 2001 unless ot her wise st at ed.
B4.1 Introduction
Capit al allowances ar e a tax deductible allowance given when a trader incurs s. 2 qualifying capital expenditure. The t r ader would not get a r evenue deduct ion f or t he expendit ur e because it has an enduring benefit f or t he t rade and is t her ef or e r egar ded as capit al. I t will however be a business cost and t her ef or e t he t r ader should be able t o claim a deduct ion against t axable pr of it s. This is done by means of a capit al allowance.
The amount of t he capit al allowances available depend on t he t ype of qualif ying expendit ur e. All allowances ar e laid down in st at ut e. The allowance could be as lit t le as 4%, it could be as high as 100% - it depends on t he t ype of expendit ure and t he t ype of business incur r ing t he expendit ur e.
Capit al expendit ur e f alls int o 3 br oad cat egor ies:
- expendit ur e on plant and machinery (by f ar t he most common); and s. 1(2)(a) - expendit ur e on industrial buildings (ver y common); and.
- other expendit ur e (less common), such as on agr icult ur al buildings.. s.. 1(2)(b)
In this chapter we will look at the definition of plant and machinery. In subsequent chapt er s we will look at how we calculat e t he var ious t ypes of allowances.
You should not e t hat capit al expendit ur e will include any ir r ecover able VAT. This is VAT which t he t rader is unable t o claim back f or var ious r easons - t his will become clear er once you have st udied t he VAT par t of your cour se.
B4.2 Definition of “Plant and Machinery”
The def init ion of plant and machiner y is f ound in t he Capit al Allowances s. 21- s. 33 Act of 2001 (CAA 2001). There is also a significant body of case law discussing what is and what is not plant . CAA 2001 def ines what is non-qualif ying expendit ur e. Ther ef or e if an it em is not wit hin t he non-qualif ying expendit ur e, by eliminat ion it is likely t o be r egar ded as plant . Capit al Allowances - Def init ion 31
The non-qualif ying expendit ur e is br oken down int o “buildings”, and “structures s. 21 and land”. The non qualif ying expendit ur e included under buildings can be f ound wit hin S.21 CAA 2001. There is a list called List A in t his sect ion. I f a par t icular it em is wit hin List A, it is specif ically excluded and is therefore unlikely to qualify as plant and machiner y
Similarly wit hin S.22 CAA 2001, t here is a list (List B), which ident if ies s. 22 expendit ur e in connect ion wit h st r uct ur es and land which should not be regarded as plant or machinery. So you can see t hat t he legislat ion is ver y usef ul in det er mining whet her somet hing is plant or not .
Ther e is also a ver y impor t ant override wit hin t he legislat ion. This can be f ound s. 23 at S.23 CAA 2001 wit hin List C. Essent ially if expendit ur e is within List C it is likely to qualify as plant and machiner y.
I t could t her ef or e be t hat expendit ur e looks as though it falls within S.21 CAA 2001 (and would t her ef or e not qualif y f or allowances), but if you can specif ically f ind it wit hin S.23, t hen S.23 over r ides t he or iginal exclusion, and t he expendit ur e will pr obably be t r eat ed as plant and will qualif y f or allowances
Even if an it em in included wit hin List C, it must st ill sat isf y t he case law t est of “f unct ion ver sus set t ing”.
This ver y impor t ant t est asks whet her ;
(i) t he asset in quest ion f or ms par t of t he set t ing in which t he t r ade is car r ied on?; or
(ii) t he asset in quest ion is somet hing which a t r ader act ively uses in his t r ade, i.e. does t he asset per f or m a f unct ion in t he business?
I f t he asset has a f unct ion, it will be plant and capit al allowances can be claimed. However , if expendit ur e has been incur r ed by t he t r ader on par t of t he set t ing wit hin which he r uns his business, it will not be plant and no allowances can be claimed. This was est ablished of J Lyons & Co v At t or ney Gener al and has been r evisit ed many t imes by t he Cour t s in deciding what is or is not “plant ”.
s. 21 B4.3 Buildings – s. 21 CAA 2001
Under t he buildings exclusion wit hin S.21 CAA 2001, t he t er m “building” includes: - an asset which is incor por at ed in t he building; - an asset which, alt hough not incor porat ed in t he building (because per haps it is moveable), is in t he building and is of a kind which would nor mally be incor por at ed in t he building; - an asset t hat is in or connect ed wit h t he building and is in List A.
You can see t hat if an it em is incor por at ed in t he building, or it is nor mally incor por at ed, but on t his par t icular occasion it is moveable, it is likely t o be excluded under (a) or (b).
32 Principles of Business Taxat ion ‘Finance Act 2006’
List A pr ovides f ur t her clar if icat ion as t o it ems included wit hin t he t er m “building”, specif ically det ailing t he f ollowing:
Walls, f loor s, ceilings, door s, gat es, shut t er s, windows, st air s. Mains ser vices and syst ems f or wat er , elect r icit y and gas. Wast e disposal syst ems. Sewer age and dr ainage syst ems. Shaf t s or ot her similar st r uct ur es. Fir e saf et y syst ems.
No gr eat sur pr ises t her e, but List A does clar if y t hat expendit ur e on t hese par t icular it ems (unless lat er over wr it t en by List C), would be r egar ded as expendit ur e on “buildings” and t her ef or e would not qualif y as “plant ”.
B4.4 Structures and Land – s.22 CAA 2001 s. 22
Under S.22, plant and machiner y does not include expendit ur e on t he f ollowing:
The pr ovision of a st r uct ur e or ot her asset in List B; or Any wor ks involving t he alt er at ion of land. Land is not plant , but List B is wor t h a close look and cont ains t he f ollowing: Tunnel br idge, viaduct et c. Pavement , r oad, car par k. Canal or basin. Dam, r eser voir s et c. Docks, har bour s, whar f s. Dykes and sea walls.
Again no gr eat sur pr ises her e. You would have t o be f air ly opt imist ic t o ar gue t hat a t unnel, f or example, was a piece of plant . However , t o be saf e do check t hat your it em is not wit hin List C as anyt hing in List C over r ides List B.
B4.5 Override – s. 23 CAA 2001 s. 23
S.23 t ells us t hat t hat S.21 and S.22 do not apply t o t he f ollowing:
Ther mal insulat ion of indust r ial buildings. Fir e saf et y. Saf et y at designat ed spor t s gr ounds. Saf et y at r egulat ed st ands at spor t s gr ounds. Saf et y at ot her spor t s gr ounds. Per sonal secur it y. Sof t war e and r ight s t o sof t war e. List C it ems. Ther ef or e expendit ur e on any of t he it ems above will be t r eat ed as expendit ur e on “plant ” and will qualif y f or capit al allowances.
List C is a long list of ver y specif ic it ems. The maj or it y of t hese it ems have been der ived f r om case law. I ndeed List s A, B and C have lar gely been const r uct ed as a Capit al Allowances - Def init ion 33 summar y of case decisions r egar ding whet her asset s const it ut e plant or not . Ther ef or e, in this area, we no longer need to refer to much case law as case precedents have now been put on t he st at ut e books and incor por at ed int o t he Capit al Allowances Act . The new legislat ion is ver y compr ehensive and is a gr eat help in det er mining whet her a par t icular it em is plant or not .
Taking a closer look at List C, which comprises some 33 items, it should be noted that whilst List C it ems nor mally qualif y as plant , it does not aut omat ically mean t he asset is plant . The asset must also f ulf il t he case law t est of f unct ion v set t ing.
I n t he maj or it y of cases t he “f unct ion” t est will be passed. However you should be awar e t hat j ust because an asset appear s on List C, it does not aut omat ically mean t hat capit al allowances can be claimed. I f a “List C” asset f or ms par t of t he “set t ing” in which a business is car r ied on, a capit al allowances claim will be denied.
Illustration 1
Consider a dr y dock. A dr y dock is ment ioned in S.22 List B, it em 5 (ie a dock, har bour , et c). These ar e t he it ems which ar e consider ed to be part of a structure or land, t her ef or e you would t hink it would not be plant and would not qualif y f or capit al allowances.
Now t ake a look at List C in S.23.
I n List C, item 23, we have the provision of dry docks. I n the case of CI R v Bar clay, Cur le & Co Lt d, a dr y dock was held t o per f or m a f unct ion in t he business, ie, r emoving a ship f r om t he r iver , holding it upr ight whilst it was being r epair ed and t hen r et ur ning it t o t he r iver when t he r epair s wer e complet e. Consequent ly t he dr y dock f ulf illed a f unct ion in t he business r at her t han j ust being par t of t he set t ing in which t he business was car r ied on.
Ther ef or e t he dr y dock will qualif y as plant , pr oviding of cour se t he f unct ional t est has been met , which it should do f ollowing t he Bar clay Cur le case.
Fr om t his exer cise we see an it em t hat init ially looked as t hough it was excluded f r om being plant because it was in List B. However , on an inspect ion of over r ides in List C we f ind it specif ically ment ions t he it em concerned. Ther ef or e we can assume t hat we ar e a long way t o est ablishing t hat a dr y dock is plant .
34 Principles of Business Taxat ion ‘Finance Act 2006’
B4.6 Case Law
Var ious cases on t he “f unct ion v set t ing” t est demonst r at e t his ver y impor t ant pr inciple. I n Dixon v Fit ch’s Gar age Lt d (1975), it was held that a garage canopy over a petrol f illing st at ion did not act ually help in t he supplying of pet r ol. I t was t her ef or e held t o be par t of t he set t ing, and t her ef or e not plant . However , if t he canopy was mor e t han j ust a canopy (ie, it per f or med a gr eat er r ole in t he business such as at t r act ing cust omer s t o t he gar age), t hen t he Revenue may accept t hat t he canopy f ulf ils a f unct ion and capit al allowances could be claimed. In an Irish case (O’Culachain v McMullan Br ot her s) t he t axpayer succeeded in such a claim as t he canopy car r ied adver t ising in illuminat ed let t er ing.
I n Schof ield v R & H Hall Lt d (1975), dockside concr et e gr ain silos wer e held t o be plant as t hey f ulf illed a f unct ion in t he t rade. They held t he grain in a posit ion f rom which it could be dischar ged t o pur chaser s. This was a f unct ion, and t he silos wer e t her ef or e plant . This has now been specif ically included in List C - I t em 28 st at es t he pr ovision of silos pr ovided f or t empor ar y st or age or st or age t anks ar e specif ically included as plant .
I n Cooke v Beach St at ion Car avans Lt d (1974), a car avan par k wit h leisur e f acilit ies, claimed t hat t he const r uct ion of t heir swimming pool f ell wit hin t he “f unct ion” pr ovisions, and was t her ef or e plant . The Revenue ar gued it was set t ing. The Cour t s agr eed t hat t he pool per f or med a f unct ion, i.e. t he car avan par k used t he swimming pool f or car r ying on it s t r ade, and it was a maj or at t r act ion t o t he car avan par k. Again t his case has now been included in t he legislat ion at List C, it em 16.
I n J ar r old v J ohn Good & Sons Lt d, moveable partitions in an of f ice to sub-divide f loor space wer e consider ed not t o be par t of t he st r uct ur e. The Revenue cont ended t hat t hey wer e par t of t he set t ing, i.e. par t of t he building in which t he t r ade was car r ied on.
The Cour t of Appeal agr eed wit h t he t axpayer and decided t hat t he par t it ions per f or med a f unct ion as t hey wer e moveable and were intended to be moved in the cour se of t he business. The par t it ions wer e t her ef or e plant . This is now included in List C at it em number 13. As you can see, a lot of case law is now incorporated int o List C in S.23 CAA 2001. I t is cert ainly wort h looking t his up if you have not alr eady done so.
Example 1
Which of t he f ollowing t ypes of expendit ur e do you f eel qualif ies as plant ?
Gener al light ing in a r et ail st or e Display light ing in st or e windows Decor at ive t apest r ies in a hot el Ship used as a f loat ing r est aur ant Adver t ising hoar dings Suspended ceiling over a st air well Suspended ceiling over eat ing ar ea
Capit al Allowances - Def init ion 35
Answer 1
Plant ? Gener al light ing in a r et ail st or e X Display light ing in st or e windows R Decor at ive t apest r ies in a hot el Ship used as a f loat ing r est aur ant X Adver t ising hoar dings Suspended ceiling over a st air well X Suspended ceiling over eat ing ar ea
Gener al light ing in a r et ail st or e does not nor mally qualif y f or plant . I t is j ust consider ed t o be par t of t he set t ing. When acquir ing a building, gener al light ing is an int egr al par t . I n List A it em 2, mains ser vices such as elect r icit y syst ems ar e not r egar ded as plant .
Display light ing in st or e windows can be regarded as plant . The light ing is normally much mor e specialised and wit h t hat it f ulf ils a f unct ion, i.e. t o at t r act cust omer s int o t he shop. I n List C it em 2, elect r ical syst ems which meet t he r equir ement s of a par t icular act ivit y ar e t r eat ed as plant .
I n Cole Br ot her s v Phillips, capit al allowances claims wer e made in r espect of light ing in a r et ail shop (par t of t he J ohn Lewis Group). Gener al light ing was held not t o be plant whilst mor e specialised light ing (eg, f or window displays et c) was held t o per f or m a f unct ion. This est ablished t he pr inciple t hat t he Revenue could r eview capit al allowance claims on a “piecemeal basis” (ie, consider ing each piece of “plant” on it s own mer it s).
Decor at ive t apest r ies in a hot el ar e r egar ded as plant. In List C item 14, decorative asset s pr ovided f or t he enj oyment of t he public in a hot el, r est aur ant or similar t r ade will be t r eat ed as plant . This was est ablished in t he case of CI R v Scot t ish & Newcast le Br ewer ies Lt d wher e t apest r ies and mur als f it t ed t o t he walls of pubs and hot els cr eat ed an “ambience and at mospher e” wit h which t o at t r act cust omer s. Ther ef or e such expendit ur e had a f unct ion r at her t han being par t of t he set t ing.
A ship used as a f loat ing r est aur ant was not r egar ded as having a f unct ion, it was act ually t he set t ing in which t he t r ade was car r ied on. (Benson v Yar d Ar m Club Limit ed (1979)).
Adver t ising hoar dings ar e specif ically wit hin List C, it em number 15. Ther ef or e it will be saf e t o assume t hat t hey qualif y as plant .
A suspended ceiling over a st air well is not r egarded as plant. It does not fulfil a f unct ion, but inst ead is mer ely par t of t he set t ing. Hampt on v For t es Aut ogr ill Lt d (1980).
A suspended ceiling over an eat ing ar ea however , could be r egar ded as plant as it f ulf ils a f unct ion in t he t r ade cr eat ing a gener al at mospher e. Exposed wir ing over an eat ing ar ea is not at t r act ive f or cust omer s!
36 Principles of Business Taxat ion ‘Finance Act 2006’
SUMMARY - CAPITAL ALLOWANCES – DEFINITION
Depr eciat ion is not allowable f or t ax pur poses. I nst ead a deduct ion in r espect of some t ypes of qualif ying expendit ur e is available.
Capit al allowances ar e given on plant and machiner y. Dif f er ent allowances ar e available f or cer t ain buildings such as indust r ial buildings and agr icult ur al buildings. Not e t hat no allowances ar e available f or of f ice buildings.
I n t he legislat ion t he def init ion of non-qualif ying expendit ur e includes buildings and st r uct ur es and land. Two list s, List A and List B, tell us what is meant by t hese t er ms and hence what does not qualif y f or plant and machiner y allowances.
Ther e ar e some except ions t o t he exclusions given in List C which must t her ef or e always also be checked.
The f inal t est which comes f r om case law and must always be sat isf ied is ‘f unct ion v set t ing’.
To qualif y f or capit al allowances t he asset must f ulf il a f unction in the trade rather t han be simply par t of t he set t ing in which t he t rade is carried on.
B5: CAPITAL ALLOWANCES - COMPUTATION
I n t his chapt er you will lear n t he r ules f or comput ing capit al allowances on plant and machiner y including: - t he basic layout ; - pooling of expendit ur e; - t he FYA pool; - t he gener al pool; - cheap car s; - long lif e asset s; - expensive car s; - shor t lif e asset s.
St at ut or y r ef er ences in t his chapt er ar e t o CAA 2001 unless ot her wise st at ed.
B5.1 Basic computational layout
Capit al allowances comput at ions ar e pr epar ed f or account ing per iods, eg f or t he s. 6 year ended 31 December 2006. Capit al allowances ar e a t r ading expense f or a business and should be deduct ed in arriving at t he t rading income f igure f or t he account ing per iod.
Year ended 31 December 2006: £ Adj ust ed pr of it s bef or e CAs X Less: capit al allowances (CAs) (X) Tr ading I ncome X
The t r ading income (i.e. af t er CAs) would t hen be t axed in 2006/ 07 under CYB.
To calculat e t he CAs we st ar t wit h t he t ax wr it t en down values br ought f or war d f r om t he pr evious per iod. We t hen add in any addit ions in t he per iod (t he pr ice paid f or any plant or machiner y) and t ake of f any disposals (t he sale pr oceeds). When deduct ing pr oceeds we r est r ict t he deduct ion t o t he or iginal cost s of t he asset (see lat er ). This gives us t he t ot al amount on which we can claim allowances.
Allowances ar e calculat ed at 25%. These ar e deduct ed leaving t he wr it t en down s. 56 value t o car r y f or war d t o next year . £ Wr it t en down value (WDV) br ought f or war d X Addit ions (pur chase pr ice) X Disposals (sale pr oceeds – restricted to cost) (X) X Allowances @ 25% (X) Wr it t en down value (WDV) car r ied f or war d X 38 Principles of Business Taxat ion ‘Finance Act 2006’
B5.2 Pooling of expenditure s. 53
Wit hin t he capit al allowance comput at ion t her e will be var ious “heads” of expendit ur e. These ar e:
Fir st year allowance pool Gener al pool Long lif e asset s Expensive car s Shor t lif e asset s
B5.3 The first year allowances pool s. 39
The f ir st year allowance (FYA) pool will include expenditure on plant & s. 52 machinery qualifying for first year allowances. FYAs ar e nor mally available at
40% on qualif ying purchases. This 40% rate has been in f orce since July 1998. However , f or some businesses a 50% r at e applies (which we shall look at in t he s. 46 next session). Qualif ying pur chases excludes car s - mor e on t his lat er .
Addit ions qualif ying f or f ir st year allowances ar e ent er ed int o t his FYA pool. The FYA is deduct ed and t he balance is t r ansf er r ed t o t he gener al pool at t he end of t he per iod. Ther e will never be a balance car r ied f or war d or br ought f or war d on t he FYA pool.
Illustration 1
Assume a t r ader has a wr it t en down value br ought f or war d on t he gener al pool of £ 100,000. I n t he year asset s qualif ying f or 40% FYAs ar e pur chased f or £ 50,000. The capit al allowances comput at ion will be:
FYA Pool Gener al Pool Allowance £ £ £ WDV b/ f 100,000 Addit ions 50,000 FYA (40%) (20,000) 20,000 WDA (25%) (25,000) 25,000 Tr ansf er t o gener al pool (30,000) 30,000 WDV c/f 105,000 ______Tot al allowances 45,000
B5.4 The general pool
The gener al pool includes anyt hing which is not specif ically included elsewher e. For example, plant and machiner y would go int o t he general pool if it did not qualif y f or a f ir st year allowance. Capit al Allowances - Comput at ion 39
s. 74 B5.5 Cheap cars
For account ing per iods ending bef or e 1 April 2000, all cars purchased which cost £ 12,000 or less wer e pooled t oget her in t he “cheap car pool”.
The cheap car pool has now been abolished. Addit ions of “cheap” car s now go int o t he general pool and obt ain writ ing down allowances (WDAs) at 25%. There are no FYAs on car s.
s. 91 B5.6 Long life assets
Long lif e asset s ar e asset s wit h a pr edict ed usef ul lif e of at least 25 year s. We ar e looking at ver y dist inct ive expendit ur e her e – eg, in power st at ions et c, wher e t he expect ed usef ul lif e of asset s used in t he business is a long t ime.
Long lif e asset s are kept in a separate pool - t hey do not qualif y f or FYAs and do not go int o t he gener al pool. Expendit ure on long lif e asset s will qualif y f or a s. 102
writing down allowance of only 6%. This is subst ant ially lower t han t he nor mal 25% because t he lif e of t he asset is longer t han a nor mal asset – 25 year s is longer t han you would expect a nor mal piece of plant or machiner y t o last .
However , t hese rules will not apply (i.e. t he asset will not be t r eat ed as a long s. 99 lif e asset ), where expenditure in the year on such assets does not exceed
£100,000 in t ot al. These special “6%” r ules will t her ef or e most commonly apply t o lar ge companies.
I f t he special r ules do not apply, t he asset would qualif y f or FYAs and any r esidue would be t r ansf er r ed t o t he gener al pool at t he end of t he per iod.
This £ 100,000 limit is adjusted f or short accounting periods. For example, if a trader dr aws account s f or a six mont h account ing per iod, t he long lif e asset limit would be £ 50,000. The £ 100,000 limit is also adj ust ed f or t he number of associat ed companies – mor e on t hat when you cover associat es wit hin your Cor por at ion Tax st udies.
I f an asset is acquir ed second-hand and had or iginally r eceived a 25% wr it ing down allowance, it will cont inue t o obt ain r elief at 25%.
I f an asset has been t r eat ed as a long lif e asset by a seller , t he buyer (r egar dless of how much he buys t he asset f or ) will also have t o t r eat t he asset as a long lif e asset - once a long lif e asset , always a long lif e asset .
B5.7 Expensive cars
An expensive car is any car cost ing more than £12,000. Each expensive car must be shown separ at ely in it s own capit al allowances column. Expensive car s s. 74
ar e not pooled with any other assets.
40 Principles of Business Taxat ion ‘Finance Act 2006’
The annual writing down allowance is restricted to the lower of: 25%; or s. 75
£ 3,000
When t he car is sold, a balancing allowance or char ge will ar ise.
Illustration 2
A t r ader dr aws account s t o 31 December . At 1 January 2005, t he wr it t en down value br ought f or war d is £ 90,000 on t he gener al pool and £ 20,000 on a BMW 735. I n t he year t he t rader bought an Audi A6 f or £ 24,000 and sold t he BMW f or £ 12,000. The capit al allowances comput at ion will be:
Y/ e 31.12.05 Pool BMW 735 Audi A6 Allowances £ £ £ £ WDV b/f 90,000 20,000 Addit ion 24,000 Disposal (12,000) Balancing Allowance 8,000 8,000 WDA (25%) (22,500) 22,500 WDA (restricted) ______(3,000) 3,000 WDV c/f 67,500 21,000 33,500
A balancing adj ust ment is made ever y t ime a “non pooled” asset (such as an expensive car ) is sold.
I n t his inst ance, as t he car has been sold f or less than its “tax value”, a balancing allowance ar ises. The balancing is allowance is t r eat ed in t he same way as a nor mal capit al allowance, i.e. it incr eases t he t ot al CAs due f or t he per iod.
I f t he car had been sold f or more than its “tax value” (ie f or mor e t han £ 20,000 in t his example), a balancing char ge would have ar isen. A balancing char ge is ef f ect ively a “negat ive” allowance and will r educe t he t ot al CAs available f or t he per iod.
The wr it t en down values br ought f or war d at 1 J anuar y 2006 are £ 67,500 and £ 21,000.
The capit al allowances comput at ion f or t he next per iod (y/ e 31 December 2006) will be:
Y/ e 31.12.06 Pool Audi A6 Allowances £ £ £ WDV b/f 67,500 21,000 WDA (25%) (16,875) 16,875 WDA (restricted) ______(3,000) 3,000 WDV c/f 50,625 18,000 19,875
Capit al Allowances - Comput at ion 41
B5.8 Short life assets s. 83 – s. 84
An elect ion can be made t o depool cer t ain asset s which have a pr edict ed useful s. 85 life of no more than 4 years. The ef f ect of t he elect ion is t hat t he asset s
ar e dealt wit h separ at ely, i.e. t hey ar e not put int o t he gener al pool but inst ead st and on t heir own in a separ at e column.
A balancing allowance will usually ar ise if t he asset is sold wit hin t he 4 year per iod. s. 86
I f t he asset is st ill in use mor e t han 4 year s of t he end of t he year of acquisit ion (i.e. af t er 5 lot s of WDAs have been claimed on it ), t he wr it t en down value is t r ansf er r ed t o t he gener al pool.
Ther e is no downside t o making a shor t lif e asset elect ion (ot her t han having t o do t he associat ed paper wor k). We deal wit h t he asset separ at ely f or 4 year s. I f it is sold wit hin 4 year s of t he end of t he per iod of acquisit ion and pr oceeds ar e less t han t he wr it t en down value br ought f or war d, a balancing allowance will ar ise. I f t he asset is st ill owned af t er 5 wr it e-downs, t he balance in t he shor t lif e asset column is t r ansf er r ed acr oss t o t he gener al pool.
Illustration 3
A t r ader dr aws account s f or t he year ended 31 Oct ober 2004. The writ t en down value br ought f or war d on t he gener al pool was £ 30,000. A comput er was bought f or £ 12,000 in t he period (no f irst year allowances wer e available on t he comput er ).
A shor t lif e asset elect ion has been made in r espect of t he comput er . The capit al allowances comput at ion will be:
Y/ e 31.10.04 Gener al pool Comput er Allowances £ £ £ WDV b/ f 30,000 Addition 12,000 WDA (y/e 31.10.04) (7,500) (3,000) 10,500 22,500 9,000 WDA (y/e 31.10.05) (5,625) (2,250) 7,875 16,875 6,750 WDA (y/e 31.10.06) (4,219) (1,688) 5,907 12,656 5,062 WDA (y/e 31.10.07) (3,164) (1,266) 4,430 9,492 3,796 WDA (y/e 31.10.08) (2,373) (949) 3,322 7,119 2,847 Tr ansf er t o pool 2,847 (2,847) 9,966 WDA (y/e 31.10.09) (2,492) 2,492 7,494
42 Principles of Business Taxat ion ‘Finance Act 2006’
I f t he comput er had been sold at any t ime dur ing t he f ir st f our year s f or less t han it s wr it t en down value, a balancing allowance would have been available.
I f however t he or iginal expendit ur e had been put int o t he gener al pool, t he pr oceeds would simply be deduct ed f r om t he gener al pool and no balancing allowance would be given.
The ef f ect of “depooling” an asset int o it s own column is t o give t he t r ader t he oppor t unit y of realising the balancing allowance sooner t han would ot her wise be t he case.
Example 1
Below is a pr of or ma capit al allowance comput at ion f or t he year ended 30 J une 2005. Ther e is a wr it t en down value br ought f or war d on t he gener al pool and a BMW car . We ar e t hen given t he nor mal headings - addit ions, disposals, f ir st year allowances at 40%, wr it ing down allowances at 25%, balancing allowance, t r ansf er and wr it t en down value car r ied f or war d.
Assume t hat t he BMW car is sold f or £ 11,000 in t he year , a Skoda car is bought f or £ 8,000 and some equipment is pur chased f or £ 6,000.
Compute the allowances due and complete the computation.
FYA Pool Gener al Pool BMW car Allowances £ £ £ £ WDV b/f 102,000 15,000 Addit ions:
Disposals:
FYA ( ) WDA ( ) BA ( )
Tr ansf er t o gener al pool ( )
WDV c/f
Tot al allowances
Capit al Allowances - Comput at ion 43
Example 2
Ted owns an engineer ing business in Shef f ield. I n t he year t o 30 Sept ember 2005 t he f ollowing inf or mat ion is given:
WDV b/f £ Gener al pool 60,000 Expensive car 10,000 Long lif e asset 104,000 Short life asset (acquired 1.7.00) 20,000 Addit ions: Plant and equipment (40% FYA due) 12,000 Renault Clio 9,000 Disposals – plant (or iginal cost £ 2,000) 2,800
Calculate the total allowances due for the year.
44 Principles of Business Taxat ion ‘Finance Act 2006’
Answer 1 FYA Pool Gener al Pool BMW car Allowances £ £ £ WDV b/f 102,000 15,000 Addit ions: Car 8,000 Equipment 6,000 ______110,000 Disposals (11,000)
FYA (2,400) 2,400 WDA (27,500) 27,500 BA (4,000) 4,000
Tr ansf er t o gener al pool (3,600) 3,600 WDV c/f 86,100
Tot al allowances £33,900
I t is best t o appr oach t hese pr of or ma comput at ions by dealing with additions and disposals in the year first.
The BMW was sold f or £ 11,000. Disposals pr oceeds of £ 11,000 ar e t her ef or e deduct ed in t he BMW car column.
A Skoda was pur chased f or £ 8,000, so it will be ent er ed int o t he gener al pool. Remember £ 8,000 is not enough f or t he Skoda t o be r egar ded as an expensive car . Also first year allowances are not available on cars – 25% WDAs are given on cars.
Finally, equipment pur chased f or £ 6,000 goes int o t he FYA pool.
Now deal wit h t he allowances. The BMW car has a balancing adjustment as it is in it s own column - t he wr it t en down value is £ 15,000, t he disposal pr oceeds ar e £ 11,000, t her ef or e we have a balancing allowance of £ 4,000. We t ake t hat acr oss t o t he allowances column.
I n t he gener al pool t her e ar e qualif ying cost s of £ 110,000 on which WDAs ar e available at 25%. WDAs of £ 27,500 ar e deduct ed and t hese allowances ar e t aken acr oss t o t he allowances column. Finally, t he expendit ur e in t he FYA pool will qualif y f or 40% f ir st year allowances of £ 2,400 (again t he amount claimed is t aken acr oss and r ef lect ed in t he allowances column). Tot al allowances f or t he per iod ar e £ 33,900. This is a t r ading expense f or Tr ading I ncome pur poses.
I n or der t o complet e t he comput at ion, £ 3,600 is transferred from the FYA pool into the general pool. The wr it t en down value car r ied f or war d on t he gener al pool is £ 86,100. Capit al Allowances - Comput at ion 45
Answer 2
FYA Gener al Expensive Long lif e Short lif e Allowances Pool Pool Car asset s asset s £ £ £ £ £ £ WDV b/f 60,000 10,000 104,000 20,000 Transfer 20,000 (20,000) Additions 12,000 9,000 Disposal (2,000) 87,000 FYA (40%) (4,800) 4,800 WDA (25%) (21,750) (2,500) 24,250 WDA (6%) (6,240) 6,240 Transf er (7,200) 7,200 ______WDV c/f 72,450 7,500 97,760 35,290
The shor t lif e asset was acquir ed on 1 J uly 2000. This means t hat by t he st ar t of t his year we would have already taken 5 WDAs t o dat e, so we must transfer that short life asset to the general pool.
The Renault Clio bought f or £ 9,000 goes int o t he gener al pool. Remember t her e ar e no f ir st year allowances ar e given on car s.
We also have a disposal in t he year . We restrict the disposal proceeds to the actual cost of the asset. So £ 2,000 is deduct ed in t he gener al pool. This leaves us wit h £ 87,000 of expendit ur e in t he gener al pool which will qualif y f or t he 25% wr it ing down allowance.
Next we will deal wit h t he f irst year allowance of 40% on t he equipment cost ing £ 12,000. £ 4,800 goes acr oss int o t he allowances column.
We also have WDAs of 25%. These ar e £ 21,750 on t he gener al pool and £ 2,500 on t he expensive car . That means we put a f ur t her £ 24,250 in t he allowances column.
The long life asset get s a 6% WDA. £ 6,240 goes int o t he allowances column.
We t r ansf er t he balance on t he FYA pool int o t he gener al pool at t he year end and show t he car r ied f or war d values f or complet eness.
46 Principles of Business Taxat ion ‘Finance Act 2006’
SUMMARY - CAPITAL ALLOWANCES - COMPUTATION
Capit al allowances ar e given on t he gener al pool of plant and machiner y at 25% p.a. on a r educing balance basis.
The WDV b/ f is incr eased by addit ions, decr eased by disposals and t he balance is wr it t en down at 25%.
Some addit ions will qualif y f or a higher allowance in t he f ir st year pr ior t o being added int o t he gener al pool.
Car s cost ing less t han £ 12,000 go int o t he gener al pool.
Expensive car s cost ing mor e t han £ 12,000 are not pooled but have t heir own column. The 25% WDA is limit ed t o £ 3,000 p.a.
Asset s cost ing at least £ 100,000 in aggr egate and wit h a pr edict ed usef ul lif e of 25 year s or mor e ar e pooled separ at ely. Such long lif e asset s ar e only wr it t en down at 6% p.a.
If asset is expected to be sold at a loss within 4 years, an election can be made to depool it t o cr yst allise a balancing allowance on sale. I f st ill in use 4 year s af t er t he end of t he per iod of acquisit ion, a shor t lif e asset is t r ansf er r ed int o t he gener al pool.
B6: INDUSTRIAL BUILDINGS ALLOWANCES
I n t his chapt er you will cover t he r ules f or allowances on indust r ial buildings including: - def init ion of an indust r ial building; - qualif ying t r ades; - r elevant int er est ; - qualif ying expendit ur e; - t he allowances; - disposal of an indust r ial building; - pur chasing a used building; - buildings in Ent er pr ise Zones.
St at ut or y r ef er ences in t his chapt er ar e t o CAA 2001 unless ot her wise st at ed.
B6.1 Introduction s. 271
The def init ion of an indust r ial building is impor t ant because only t hose buildings qualif ying as “industrial” buildings will be ent it led t o indust rial buildings allowances (I BAs).
I BAs ar e available if ;
(i) t he expendit ur e concer ned is incur r ed in t he cour se of const r uct ion of a qualif ying building; and (ii) t he expendit ur e is qualifying expenditure. Not all cost s incurred in t he const r uct ion of a building ar e qualif ying expendit ur e f or I BA pur poses.
B6.2 Qualifying building
A qualif ying building is a building used in a qualif ying t r ade or a qualif ying hot el.
The specif ic cr it er ia f or a qualif ying hot el can be f ound at S.279 CAA 2001. A qualif ying hot el should have at least 10 let t ing bedr ooms, be open f or at least 4 mont hs dur ing t he per iod Apr il t o Oct ober and pr ovide a ser vice of t he making s. 279 of beds, cleaning of r ooms and of f er ing br eakf ast and dinner as a nor mal par t of t he hot el’s business.
A qualifying sports pavilion is also a qualif ying building. I n t his inst ance it does not mat t er what t he t r ade or t he business is. For example, a bank could have a s. 280 spor t s club wit h a spor t s pavilion which is made available f or st af f - t hat spor t s pavilion would qualif y f or indust r ial buildings allowances.
Finally, a qualif ying building would also be a building in an Enterprise Zone. The s. 281 st rict crit eria are laid out at S.281 CAA 2001.
48 Principles of Business Taxat ion ‘Finance Act 2006’
B6.3 Qualifying expenditure
The def init ion of “qualif ying expendit ure” is f ound at S.292 CAA 2001. Br oadly s. 292 t his will include capit al expendit ur e on t he const r uct ion of a qualif ying building.
I t should be appr eciat ed t hat allowances ar e given t o t he per son wit h t he relevant interest in t he building. This is normally t he freeholder - we will look s. 286 at t his lat er on in t his chapt er.
All t he det ailed r ules ar e laid out logically in t he legislat ion.
“Const r uct ion cost s” do not include the cost of acquiring the land or any planning f ees t hat may be incur r ed. Const r uct ion cost s will include preparing, s. 273 cutting, tunnelling or levelling t he land and any architects, quantity surveyors and engineers fees, pr oviding t hat t he building is act ually const r uct ed.
B6.4 Qualifying Trade s. 274
I n order for a building to be qualifying, it must be used in a “qualifying trade”. The def init ion of a “qualif ying t r ade” is ext r emely impor t ant and is and def ined at s.274 CAA 2001.
A qualif ying t r ade means a trade of a kind described in Table A or an undertaking of a kind described in Table B, if t he undert aking is carried on by way of a t r ade. Table A trades ar e t he mor e impor t ant of t he t wo and ar e mor e common.
S.275 CAA 2001 includes an ext ension t o nor mal qualif ying t r ade buildings and st at es t hat a building is also in use f or a qualif ying t r ade if it is a staff welfare s. 275 building. This could be a canteen or a social club of a manuf act ur ing company.
St af f welf ar e buildings ar e dif f er ent t o spor t s pavilions because t o qualif y as a st af f welf ar e building, the building has to be used by a company with a qualifying trade. Spor t s pavilions, as we saw ear lier , did not need a qualif ying t r ade at t aching - any trade wit h a spor t s pavilion would qualif y f or I BAs on t hat spor t s pavilion.
B6.5 “Table A” trades
Table A qualif ying t r ades ar e impor t ant and ar e laid out at S.274 CAA 2001.
Qualif ying t r ades ar e st r ict ly def ined as:
- manufacturing goods or mat er ials; - processing, i.e. t he subj ect ion of goods or mat er ials t o some sor t of pr ocess; - storage of goods or mat er ials; - agr icult ur al cont r act ing, f or example cont r act har vest ing. - wor king f ar m plant at ions, f ishing and miner al ext r act ion.
I ndust rial Buildings Allowances 49
The most common ar eas ar e manufacturing, processing and storage.
B6.6 Processing
The legislat ion st at es t hat pr ocessing is t he “subjection of goods or materials to a process”. This definition has been tested in var ious cases wher e t r ader s f elt t hey had buildings which wer e used f or t he subj ect ion of goods or mat er ials t o a pr ocess.
The case of Bour ne v Nor wich Cremat or ium Limit ed (1964) concer ned a cr emat or ium. The t r ader f elt t hat he was “subj ect ing goods t o a pr ocess”, t her ef or e his cr emat or ium should qualif y as an indust r ial building. I n t his case it was held t hat human bodies ar e not goods and t her ef or e no I BAs wer e available.
Kilmar nock & Equit able Co-oper at ive Societ y Lt d v CI R (1966) involved a t r ader scr eening and packing coal. I t was held t hat t his was subj ect ing goods or mat er ials t o a pr ocess. Consequent ly t he building in which t his t ask was under t aken was an indust r ial building and I BAs wer e due.
Buckingham v Secur it as Proper t ies Lt d (1980) concer ned wage packet ing. This involved coins and not es being count ed and put int o pay packet s. Alt hough it was held t hat a pr ocess was being under t aken, not es and coins wer e not held t o be goods, t her ef or e t his was not an indust r ial building.
Anot her case involved unpacking, r elabelling and r epacking. This could quit e conceivably be a super mar ket wher e labelled br ands ar e r eceived, unpacked and t hen put int o boxes wit h t he super mar ket ’s own brand. I n t his part icular case it was held t hat unpacking, r elabelling and r epacking was not a pr ocess - it was a mer e pr eliminar y t o a sale.
B6.7 Storage
The ot her impor t ant ar ea of qualif ying t r ades is st orage. Wit hin S.274 CAA 2001, “st or age” could be a trade which consists of the storage of goods or mat er ials which ar e t o be used in the manufacture of ot her goods or mat er ials.
St or age could also mean t he st or age of goods or mat er ials which ar e t o be subjected in the course of trade to a process. I n t his lat t er case, goods or mat er ials could be st ored by one t r ader and be subjected to a process by another trader.
The most r elevant case her e is Crusabr idge I nvest ment s Lt d v Casings I nt er nat ional Lt d (1979). I n t his case, a building was used t o st or e used t yr es which wer e t o be sent t o manuf act ur er s t o be r emoulded. “Remoulding of t yr es” was consider ed t o be an industrial process. Consequent ly, t he building storing the tyres was an industrial building. I t did not mat t er t hat t he t yr es wer e not t o be subj ect t o a pr ocess by t he t r ader - t hey wer e t o be subj ect t o a pr ocess by another t rader and t hat is suf f icient f or t he building t o qualif y f or I BAs.
50 Principles of Business Taxat ion ‘Finance Act 2006’
The Revenue t hought t his was t oo gener ous a pr ovision and have t r ied t o clar if y t he limit at ions of t his legislat ion. They saw t his pr ovision as pot ent ially opening all kinds of door s f or claims, f or example I BA claims f or t he st or age f acilit ies of builder s’ mer chant s. Following t he Crusabr idge decision, t hese st or age f acilit ies would qualif y f or I BAs as t he goods st or ed and sold by a builder s mer chant wer e t o be used in a f ur t her pr ocess.
Consequent ly - accor ding t o a Revenue int er pr et at ion - st or age should f or m a significant, separate and identifiable part of the trade and it should be conducted as a purpose and end in itself, not j ust a necessar y and t r ansit or y incident of t he business. I n t he Crusabr idge case, t he building would st ill qualif y f or I BAs as t he collect ion and st or age of t yr es was deemed t o be an essential part of the business in itself. However , f ollowing t his int er pr et at ion, it is unlikely t hat st or age f acilit ies used by builder s mer chant s and similar t r ades would qualif y f or I BAs.
Par t C of t he legislat ion says st or age will also include t he st or ing of goods or mat er ials which have been manuf act ur ed, or pr oduced or subj ect ed in t he cour se of a t r ade t o a pr ocess, but have yet t o be deliver ed t o any pur chaser . Not e her e t hat we must have a pur chaser . Ther ef or e if a t r ader is involved in a r et ail t r ade and has a war ehouse st or ing goods pr ior t o t heir being sold t hr ough his own r et ail out let s, t hat war ehouse is unlikely t o qualif y as an indust r ial building as t he goods ar e not being deliver ed t o a pur chaser .
Finally t he st or age of goods or mat er ials on t heir ar r ival in t he UK f r om a place out side t he UK also qualif ies.
B6.8 “Table B” trades s. 286
Going back t o S.274 CAA 2001, a qualif ying t rade also means an under t aking of a kind descr ibed in Table B if t he under t aking is car r ied on by way of a t r ade. The t r ades list ed ar e elect r icit y, wat er , hydr aulic power , sewer age, t r anspor t , highway under t akings, t unnels, br idges, inland navigat ion and docks. They ar e not as common as manuf act ur ing t r ades, and if you ar e st udying for exams it is unlikely that you will be asked quest ions concer ning t hese kinds of t r ades. It is much more likely you will be dealing wit h t r ades as laid down in Table A.
B6.9 Relevant Interest
I BAs will be available t o t he per son who has t he “r elevant int er est ” in t he par t icular pr oper t y. Relevant int er est is def ined wit hin S.286 CAA 2001.
The relevant interest is t he int erest in t he building t o which t he per son who incur r ed t he expendit ur e on t he const r uct ion of t he building was ent it led when t hey incur r ed t he expendit ur e. Ther ef or e if a per son owns t he f r eehold and spends money on t he const r uct ion of a building, t hen t he r elevant int er est is t he f r eehold - t hat is t he int er est t he per son had when he spent t he money.
I ndust rial Buildings Allowances 51
I f a t r ader (individual or company) owns t he f r eehold of a f act ory, in all probabilit y t hat f reeholder will claim I BAs on t hat f act or y as he has t he “r elevant int er est ” in a building and car r ies on a qualif ying t r ade.
I f t he t r ader wer e t hen t o build an ext ension t o t he f act or y, t his is t r eat ed as a separ at e “pot ” of expendit ur e f or I BA pur poses, ie, as a separ at e asset wit hin t he I BA comput at ions. The r elevant int er est in t he extension expenditure is t he int er est t hat t he per son had when t hey spent t he money. So in t his example, t he r elevant int er est is t he freehold as t hat is t he int er est t hat t he t r ader had when he incur r ed t he expendit ur e.
Relevant int er est becomes mor e complicat ed when we are dealing wit h lessor s and lessees. Assume, f or example, a t r ader has a f r eehold f act or y which cost £ 1m. The f r eeholder does not act ually use t he f act or y himself . He gr ant s a lease t o anot her t rader and it is t his t rader (t he”lessee”) who uses t he f act or y in his t r ade. Who has t he r elevant int er est ?
In this example, it will be the freeholder. The f r eeholder spent £ 1m on t he f act or y and when he spent it he owned t he f r eehold. The r elevant int er est t her ef or e lies wit h t he f r eeholder .
I t is the freeholder who may be ent it led t o I BAs. These allowances will be set against t he f r eeholder ’s rental income from the letting of the factory and would t her ef or e be an allowable expense f or Proper t y I ncome pur poses.
The availabilit y of I BAs depends on what t he lessee is using t he building f or . I f t he lessee uses t he building f or a qualif ying t r ade, I BAs can be claimed by t he f r eeholder (ie, t he landlor d). So alt hough t he freeholder may be entitled to IBAs, his entitlement is based on the lessee’s use of the building. Accor dingly, clauses ar e of t en inser t ed int o r ent al agr eement s t o ensur e t hat lessees must use t he building f or a qualif ying t r ade.
I f t he lessee built an ext ension and paid f or t he ext ension t hemselves, t he lessee would hold the relevant interest in the extension, i.e. when t hey spent t he money on t he ext ension t hey owned t he lease, so t her ef or e t he r elevant int er est f or t he ext ension is t he lease. The lessee would be ent it led t o I BAs on t he extension expenditure.
B6.10 Granting a long lease s. 290
Ther e is one quir k t o r elevant int er est and long leases. This is highlight ed in S.290 CAA 2001. “Long leases” in t his case ar e leases of more than 50 years duration.
Consider a f r eeholder who gr ant s a 60 year lease on his f act or y t o a lessee f or a pr emium of £ 200,000. Cur r ent ly t he r elevant int er est is owned by t he f r eeholder . However , t he f r eeholder may not need t he I BAs - f or example t he f r eeholder may be a non-t axpayer , such as a local aut hor it y (such or ganisat ions ar e not gener ally liable t o t ax). Ther ef or e I BAs could go t o wast e.
52 Principles of Business Taxat ion ‘Finance Act 2006’
When a long lease is gr ant ed, it is possible f or t he f r eeholder and lessee t o j oint ly elect t o t r ansf er t he r elevant int er est f r om t he f r eeholder t o t he lessee. The lessee is deemed t o have acquir ed an indust r ial building f or t he purchase price of £ 200,000 - t he lease pr emium. Ther ef or e t he lessee will obt ain I BAs on this £ 200,000 - he now owns t he r elevant int er est by elect ion and can claim I BAs t o set against t r ading pr of it s.
Example 1
Which of t he f ollowing buildings may qualif y as an indust r ial building?
Yes ? No ?
Building used f or t he mechanical pr ocessing of cheques. Plant hir e depot used f or r epair and maint enance of plant bet ween hir ings. War ehouse st or ing bought -in goods f or onwar d sale t o t he public. A spor t s pavilion owned by Bank Plc f or employee use. A hot el wit h eight let t ing bedr ooms
B6.11 Industrial buildings allowances
I n summar y I BAs ar e available on: - gener al indust r ial buildings; - qualif ying hot els ; - buildings in ent er pr ise zones; and - spor t s pavilions.
Specif ically excluded ar e: - dwellings; - r et ail shops; - showr ooms; - non-qualif ying hot els; and - of f ices.
B6.12 Qualifying expenditure s. 292
Qualif ying expendit ur e is based on t he const r uct ion cost of t he building. Land is always excluded but t he pr epar ing, cut t ing, t unnelling or levelling of t he land, t oget her wit h t he ar chit ect s f ees ar e included. Legal f ees do not qualif y.
Qualif ying expendit ur e also includes the non-industrial parts if together they s. 283 amount t o less than 25% of t he t ot al const r uct ion cost . The per cent age was 10% f or buildings const r uct ed bef or e Mar ch 1993. Theref ore if a t rader builds a f act or y which has some of f ice space in it , we look at t he t ot al const r uct ion cost . I f t he cost s of t he of f ices ar e less t han 25% of t ot al cost , I BAs ar e given on t he t ot al const r uct ion cost , including t he of f ices. I ndust rial Buildings Allowances 53
Example 2
Clar ke Kent pur chased some land on 1 Oct ober 2003 f or £ 200,000. I n t he year t o 30 J une 2004 he spent t he f ollowing: £ Levelling and cut t ing t he land 35,000 Architects f ees 15,000 Fact or y const r uct ion (including of f ices £ 160,000) 600,000
Calculat e t he qualif ying expendit ur e f or I BA pur poses.
B6.13 The allowances
The allowances t hat can be claimed on indust r ial buildings ar e:
a) The initial allowance
I nit ial allowances used t o be available in t he per iod in which t he expendit ur e is incur r ed. Cur r ent ly, however , t her e is no init ial allowance available.
b) The writing down allowance s. 309
- s.310 This is a 4% straight line allowance – i.e. 4% on cost ever y year .
Wr it ing down allowances ar e given if t he building is in industrial use on the last day of the accounting period. What t he building is used f or t hr oughout t he account ing per iod is not r elevant – it is t he use on that last day which is impor t ant .
I f a building is in non-industrial use at the end of the accounting period, no IBA will be given. I nst ead a notional 4% writing down allowance is deduct ed f r om t he pool of qualif ying expendit ur e. The notional WDA does not r educe t axable pr of it s f or t hat year – it mer ely r educes t he balance of qualif ying expendit ur e going f or war d.
Empty periods (ie, when t he building is vacant and not being used f or any s. 285 pur pose) t ake on t he same form as the immediate preceding use. Theref ore if on the last day of an accounting period the building was empty, we look back to t he immediat ely pr eceding use and t r eat t he “empt y” per iod exact ly t he same as t hat pr eceding use. You may see t his r ef er r ed t o as “t empor ar y disuse”.
The WDA is time-apportioned f or shor t account ing per iods. I f t he business has a 7 mont h AP, t he WDA would be 7/ 12 x 4%. s. 310(2)
Ther e is no writing down allowance in the year of sale. Balancing allowances / char ges may apply inst ead as we shall see lat er .
54 Principles of Business Taxat ion ‘Finance Act 2006’
Illustration 1
Clar ke Kent incur r ed qualif ying expendit ur e of £ 650,000 on a building in t he year t o 30 J une 2004. The building was br ought int o use on 1 August 2004. I t was used f or indust r ial pur poses unt il 30 Sept ember 2007. The pr oper t y r emained empt y unt il 31 August 2008. The pr opert y was in non-indust r ial use f r om 1 Sept ember 2008 t o 30 June 2009.
We will demonst r at e how t he I BA hist or y is compiled. The I BA comput at ion will be; Cost Allowances Y/ e 30 June 2004 £ £ Addit ion 650,000 Not in use on last day so no WDA yet Y/e 30 June 2005 I n indust r ial use on last day so WDA given WDA @ 4% (26,000) 26,000 Y/e 30 June 2006 I n indust r ial use on last day so WDA given WDA @ 4% (26,000) 26,000 Y/e 30 June 2007 I n indust r ial use on last day so WDA given WDA @ 4% (26,000) 26,000 Y/e 30 June 2008 Empt y on last day – pr eceding use was indust r ial so WDA given WDA @ 4% (26,000) 26,000 Y/e 30 June 2009 Non-indust r ial use on last day so Not ional WDA Notional WDA 4% (26,000) Nil WDV at 1 July 2009 £520,000 ______Allowances given £ 104,000
Not e t hat as t he building was specif ically being used f or a non-indust r ial pur pose on 30 J une 2009, no I BAs ar e available f or t his per iod. I nst ead t he r esidue of expendit ur e is r educed by a “not ional” WDA of £ 26,000 but “nil” in ent ered int o t he claim column.
Non-indust r ial use is dif f er ent f r om t he building being “empt y” which implies t hat no act ivit ies at all ar e being conduct ed in t he building. I f a building is empt y at t he end of t he per iod, I BAs will be given as nor mal if t he building was in indust r ial use in t he pr eceding per iod (as is t he case her e). I ndust rial Buildings Allowances 55
B6.14 Disposal of an industrial building s. 314 - s. 324 The amount of sale pr oceeds is t he key f act or when dealing wit h t he disposal of an indust r ial building. This is best shown by a f lowchar t .
Proceeds
Exceed cost Less t han cost
BC = Allowances 100% indust r ial Par t non indust r ial given use use
Deduct pr oceeds “Adj ust ed net f rom WDV b/ f cost ” pr inciple
I f pr oceeds exceed cost , t her e is a profit. Wher e a building is sold at a pr of it s. 318
wit hin it s “25 year t ax lif e”, the balancing charge on disposal will always be s, 320 equal to the allowances previously given. There is no exception to this rule. IBAs compensate a trader for the fall in value of an industrial building. Ther ef or e if t he building is sold at a pr of it , t her e is no f all in value. The Revenue will t hen r eclaim t he allowances given because t her e has been no cost t o t he business; t hey have made a pr of it . s. 314(4)
No balancing adjustment (allowance or charge) will arise if the building is
sold outside its “tax life”. The t ax lif e of a building is 25 years, st ar t ing f r om when it was f ir st br ought int o use. For planning pur poses, a balancing char ge can be avoided by selling t he building once t he t ax lif e has expir ed.
A prof it on the sale of a building could give rise to a chargeable gain (regardless of whet her t he t ax lif e has expired). A gain can be def er r ed under t he “r oll-over r elief ” pr ovisions if a building is r eplaced wit h anot her .
Wher e t he building is sold f or less t han cost , i.e. a loss has been made, t her e ar e t wo dif f er ent t r eat ment s.
56 Principles of Business Taxat ion ‘Finance Act 2006’
I f t he pr oper t y had been used f or 100% indust r ial pur poses t hr oughout it s s. 318
per iod of owner ship, we simply deduct the proceeds from the written down
value brought forward. This gives a balancing allowance or balancing charge in t he same way as non-pooled plant & machiner y (eg, an expensive car ). Not e t hat a balancing char ge could st ill ar ise wher e a cash loss has been made on t he sale of a building.
I f , however , t her e was part industrial and part non-industrial use, we have t o s. 319 comput e t he “adj ust ed net cost ”.
Bef or e we move on and look at t he adj ust ed net cost r ules, a quick r eminder - as discussed in t he pr evious chapt er - t hat FA 2003 has int roduced specif ic ant i- avoidance legislat ion t o deny businesses r elief f or balancing allowances ar ising wher e pr oceeds ar e low as a r esult of a t ax avoidance scheme.
B6.15 Adjusted net cost (ANC) s. 323
The net cost is t he loss on sale. I f we bought a propert y f or £ 900,000 and sold it f or £ 750,000, we have a net cost of £ 150,000.
The adj ust ed net cost (ANC) is t he indust r ial pr opor t ion of t his loss.
For example, if t he building was used f or 50% of t he t ime f or indust r ial pur poses and 50% f or non-indust r ial pur poses, t he adj ust ed net cost is;
£ 150,000 x 50% = £ 75,000
That is t he indust r ial pr opor t ion of t he net cost (ie t he loss t he t r ader has made whilst t he building was being used f or indust r ial pur poses).
We t hen compar e t he adj ust ed net cost t o t he allowances given. £ Adj ust ed net cost ANC Less: I BAs pr eviously given (I BAs) BA / (BC) BA / (BC)
The dif f er ence is a balancing char ge or balancing allowance, depending on t he level of allowances given. For example, if t he allowances given wer e, say, £ 70,000, t her e would have a balancing allowance of £ 5,000 because adj ust ed net cost is £ 75,000.
£ Adjusted net cost 75,000 less I BAs pr eviously given (70,000) Balancing Allowance £ 5,000
I ndust rial Buildings Allowances 57
Ef f ect ively, t he t r ader has made a loss of £ 75,000 whilst using t he building f or indust r ial pur poses. The Revenue has given him £ 70,000 of I BAs t o compensat e him f or t he loss. The Revenue will give t he “balance of allowances” of £ 5,000 in t he year of sale.
I f I BAs pr eviously given wer e, say £85,000, a balancing char ge would ar ise;
£ Adjusted net cost 75,000 Less: I BAs pr eviously given (85,000) Balancing Char ge £ (10,000)
The t r ader made a loss of £ 75,000 whilst using t he building f or indust r ial pur poses. The Revenue gave £ 85,000 of I BAs t o compensat e him f or t he loss. This is t oo much, so t he Revenue will claw-back £ 10,000 in t he year of sale.
Example 3
Cont inuing Clar ke Kent above, calculat e t he balancing adj ust ment if t he f act or y is sold f or £ 800,000 on 1 December 2009.
Example 4
Assume t hat Clar ke Kent sold t he pr opert y on 1 December 2009 f or £ 475,000.
The pr oper t y was in indust r ial use f rom 1 J uly 2009 t o t he dat e of sale.
Complet e t he st eps f or t he calculat ion as f ollows: a) Calculat e t he net cost b) Calculat e t he number of mont hs of indust r ial usage c) Calculat e t he number of mont hs of Tot al usage d) Calculat e t he ANC = I ndust r ial usage x net cost Tot al usage
e) Calculat e t he balancing adj ust ment
f ) Est ablish whet her it is a balancing allowance or a balancing char ge
58 Principles of Business Taxat ion ‘Finance Act 2006’
B6.16 The purchaser’s position s. 311
The pur chaser r eceives allowances based on t he f ollowing f or mula:
Residue af t er sale x 12 = Annual WDA
Remaining t ax lif e (mont hs)
The pur chaser cannot claim 4% allowances. They must use t he f or mula above t o det er mine t heir annual wr it ing down allowance. The pur chaser is entitled to the WDA if t he building is in indust r ial use on t he last day of t heir account ing per iod.
By “Residue af t er sale” we mean t he wr it t en down value bef or e sale, minus any balancing allowance at sale or plus any balancing char ge at sale, ie
£ TWDV at st ar t of AP of sale X Less BA or Plus BC (X) Residue af t er sale X
Residue af t er sale can never exceed t he pr ice paid by t he new user .
Remaining t ax lif e is simply t he unexpir ed pr opor t ion of t he t ax lif e. The t ax lif e of an indust r ial building is 25 year s (ie 300 mont hs).
Remaining t ax lif e = 300 mont hs - mont hs of use t o dat e
Example 5
Cont inuing Clar ke Kent above, calculat e t he allowances available t o t he pur chaser in each of t he t wo scenar ios (ie examples 3 & 4).
Remember : (a) (b) Sale price £800,000 £475,000 WDV at 30 June 2009 £520,000 £520,000 Balancing char ge/ (allowance) £104,000 (£43,656) Expir ed usage 64 mont hs 64 mont hs
I ndust rial Buildings Allowances 59
B6.17 Buildings in Enterprise Zones s. 281
I f a commer cial building is const r uct ed in a designat ed Ent er pr ise Zone (EZ),
init ial allowances ar e available on t he const r uct ion cost s at 100%. The init ial s.306 allowance is int ended t o encour age invest ment in ar eas wher e r egener at ion is r equir ed.
Not e t hat 100% init ial allowances ar e available f or “commercial” buildings in EZs.
“Commer cial” in t his cont ext will include shops and showrooms et c as long as
t hey ar e used f or t he pur poses of a t r ade. Offices will always qualif y f or 100% init ial allowances r egar dless of what t hey ar e used f or (except if t hey ar e used s. 281(b) as a dwelling house!).
All or par t of t he init ial allowance may be disclaimed. Ther eaf t er , wr it ing down s.306(2)
allowances ar e given on t he balance of expendit ur e at a r at e of 25% on a r educing balance basis.
Allowances ar e given eit her against t r ading income (if t he per son having t he r elevant int er est is a t r ader ) or against Proper t y income (if t he per son having t he r elevant int er est let s t he building t o a t r ader ).
Allowances ar e only given if t he const r uct ion expendit ur e is incur r ed wit hin 10 s. 298- s. 299 years of t he zone being of f icially designat ed as an Ent er pr ise Zone.
Balancing allowances and char ges will apply as f or ot her indust r ial buildings if s. 314
t he building in t he EZ is sold wit hin 25 years. I f 100% init ial allowances have been claimed, a sale wit hin 25 year s will inevit ably lead t o a balancing charge.
60 Principles of Business Taxat ion ‘Finance Act 2006’
Answer 1 Yes No
Building used f or t he mechanical R
pr ocessing of cheques. Plant hir e depot used f or r epair and R
maint enance of plant bet ween hir ings. War ehouse st or ing bought -in goods R
f or onwar d sale t o t he public. A spor t s pavilion owned by Bank Plc R
f or employee use. A hot el wit h eight let t ing bedr ooms R
A building used f or t he mechanical pr ocessing of cheques is not an indust r ial building. I n t he case of Gir obank Plc v Clar k (1998) t he pr ocessing of cheques was deemed t o be a pr ocess, but pieces of paper car r ying inf or mat ion wer e not deemed t o be goods.
A plant hir e depot used f or r epair and maint enance of plant bet ween hir ing is not an indust r ial building. I n t he case of Vibr oplant Lt d v Holland (1982), t he depot was not deemed t o be a f act or y and t he plant was not subj ect t o a pr ocess.
A war ehouse st or ing bought in goods f or onwar d sale t o t he public is not an indust r ial building. I n Dale v J ohnson Br ot her s (1951), a r et ailer or wholesaler who st or es goods f or r esale cannot claim I BAs because he himself is t he pur chaser .
A spor t s pavilion owned by a bank f or t he use of employees is an indust r ial building. S.280 CAA 2001 says t hat a building occupied by a per son car r ying on a t r ade and used as a spor t s pavilion f or t he welf ar e of employees is an industrial building - it does not mat t er t hat t he bank is not car r ying on a qualif ying t r ade.
A hot el wit h 8 let t ing bedr ooms is not an indust r ial building. I n or der t o qualif y as an indust r ial building t he hot el must have at least 10 let t ing bedr ooms (S.279 CAA 2001).
I ndust rial Buildings Allowances 61
Answer 2
£ Const r uct ion (see Not e) 600,000 Levelling and cut t ing 35,000 Ar chit ect s’ f ees 15,000 650,000
Not e £ 650,000 x 25% = £ 162,500 Of f ices cost £ 160,000 so t hey qualif y as below 25%
Answer 3
The building was sold at a pr of it so a balancing char ge ar ises equal t o t he allowances given of £ 104,000.
Answer 4
Net cost : £ (475,000 – 650,000) = £ 175,000
Tot al Use I ndust r ial Non-I ndust r ial Use Use 1.8.04̨30.9.07 38 38 1.10.07̨ 31.8.08 11 11 1.9.08̨30.6.09 10 10 1.7.09̨1.12.09 5 5 64 54 10
54 ANC = £ 175,000 x = £ 147,656 64
Balancing adj ust ment = £ 147,656 – 104,000 = £ 43,656
This is a balancing allowance as t he business can claim allowances on £ 147,656 but has only claimed £ 104,000 so f ar .
62 Principles of Business Taxat ion ‘Finance Act 2006’
Answer 5 (a) (b) Residue before sale 520,000 520,000 BC/(BA) 104,000 (43,656) Residue after sale 624,000 476,344
Limited to price paid £475,000
(a) Allowances f or pur chaser = 624,000 x 12 300 – 64
= £ 31,729
(b) Allowances f or purchaser = 475,000 x 12 300 – 64
= £ 24,153
I ndust rial Buildings Allowances 63
SUMMARY - INDUSTRIAL BUILDINGS ALLOWANCES
I ndust r ial buildings ar e buildings used in a qualif ying t r ade. Qualif ying hot els wit h 10 let t ing bedr ooms, open f or 4 mont hs f r om Apr il t o Oct ober of f er ing nor mal hot el ser vices also qualif y f or allowances. Spor t s pavilions always qualif y no mat t er what t he t r ade is. Buildings in Ent er pr ise Zones qualif y f or 100% allowances.
Qualif ying t r ades include manuf act ur ing, pr ocessing and st or age. Processing means t he subj ect ion of goods t o a pr ocess. St or age qualifies if it is of raw materials, finished goods or goods ar r iving f r om over seas. The st or age of r et ail goods pr ior t o sale does not qualif y.
The allowances ar e given t o t he t axpayer wit h t he r elevant int er est in building. This is usually t he f r eeholder but could be t he lessee in r espect of enhancement expendit ur e. I f a long lease is gr ant ed (over 50 year s) a j oint elect ion can be made t o t r ansf er t he r elevant int er est t o t he lessee.
The allowances ar e given on qualif ying expendit ur e which is t he const r uct ion cost . I t excludes land but pr epar ing/ cut t ing t he land and ar chit ect s f ees qualif y. Any non- indust r ial par t s such as of f ices, shops or showr ooms will also qualif y if they amount to less t han 25% of t he const r uct ion cost .
The allowance is 4% p.a. st raight line on cost (t ax lif e of 25 years) and is given provided t he building is in indust r ial use on t he last dat e of t he account ing period. I f t he period is not 12 mont hs in lengt h, t he 4% WDA is t ime appor t ioned.
I f t he building is in non-indust r ial use on t he last day a not ional allowance is given. Empt y per iods t ake on t he same f or m as t he immediat e pr eceding use.
I f t he building is sold as a pr of it , t her e is a balancing char ge in t he year of sale. The balancing char ge will equal I BAs pr eviously given
I f the building is sold at a loss, the ‘adjust ed net cost ’ (or indust r ial pr opor t ion of t he loss) is compar ed t o t he allowances given and a BA or BC comput ed accor dingly. I ndust r ial usage Adj ust ed net cost = x net cost Tot al usage
The pur chaser of a used building does not get a 4% allowance, inst ead t heir allowances ar e: Residue af t er sale x 12 = Annual WDA Remaining t ax lif e
The r esidue af t er sale is t he WDV of t he building including t he balancing adj ust ment at sale comput ed f or t he seller . I t is r est r ict ed t o pr ice paid.
B7: INTANGIBLE FIXED ASSETS
B7.1 Introduction
I FAs ar e r ecognised as income as t hey ar e debited / credited in determining Par a 1 Sch 29 the company’s profit or loss. The r ules ar e similar t o t he loan r elat ionship FA 2002 r ules.
B7.2 Intangible fixed assets
The t er m “I nt angible Fixed Asset ” has t he same meaning as it has f or account ing pur poses. I n par t icular it includes intellectual property which means any patent, r egist er ed trademark, design or copyright et c. I t also includes goodwill, again as def ined f or account ing pur poses.
I FAs include f ungible asset s. A f ungible asset is def ined as an asset which can be dealt in wit hout ident if ying t he par t icular asset s involved. An example would be a milk quot a in t he dair y f ar ming indust r y. Fungible asset s of t he same kind (eg successive acquisit ions of milk quotas) held by the same person in the same indust r y ar e t r eat ed as indist inguishable par t s of a single asset .
Cer t ain asset s ar e expr essly excluded f r om t he pr ovisions of Sch 29. Wher e an Par a 72 asset is excluded an opt ion or ot her r ight t o acquir e or dispose of such an asset Sch 29 FA 2002 is also excluded
Asset s ent ir ely excluded ar e r ight s over t angible asset s; oil licences; f inancial Para 73-77 asset s; r ight s in companies, t r ust s et c; and asset s held f or non commer cial Sch 29 FA 2002 pur poses et c.
Asset s excluded except as r egar ds r oyalt ies ar e; asset s held f or a lif e assur ance Par a 78-81 business; asset s held f or any mut ual t r ade or business; f ilm and sound Sch 29 FA 2002 r ecor dings; and comput er sof t war e t r eat ed as par t of cost of r elat ed har dwar e.
Asset s excluded f r om t he pr ovisions of Sch 29 t o t he ext ent specif ied are; Para 82-83 r esear ch and development expendit ur e; and capit al expendit ur e on comput er Sch 29 FA 2002 sof t war e.
B7.3 Trade and non-trade IFAs Para 30-34 Sch 29 FA 2002 I t is important to classif y I FAs according t o whet her t hey r elat e t o a t r ade, a pr oper t y business, or ar e non-t r ade.
Trading debits and credits f or m par t of DI as t hey ar e accr ued t o t he pr of it and loss account .
Debit s and cr edit s r elat ing t o a pr oper t y business ar e t r eat ed as par t of t he expense/ income of t hat pr oper t y business. I nt angible Fixed Asset s 65
Non-trade debits and credits are pooled. I f t he non-t r ade cr edit s exceed non-t r ade debit s t hen t her e is a gain char geable under DVI.
I f non-t r ade debit s exceed non-t r ade cr edit s t hen t her e is a non-trade loss on IFAs. Cer t ain r elief s ar e available f or t his loss.
B7.4 Relief for non-trade loss on IFAs Par a 35 Sch 29 FA 2002 A claim can be made t o set t he whole or part of t he loss against t he company’s total profits f or t hat per iod. Ther e is a two year time limit f or t his claim.
A claim can be made t o use t he loss under t he group relief pr ovisions which we will look at lat er .
To t he ext ent t hat t he loss has not been used in a cur r ent year claim or sur r ender ed as gr oup r elief it will be carried forward as a non-t r ade debit t o t he next account ing per iod.
B7.5 Impact on tax computations
Royalty payments ar e allowed under DI or DVI on an accruals basis.
Patent and copyright royalties ar e paid gr oss bet ween UK companies. Remember t hat all f igur es t hat appear in t he t ax comput at ion must be gr oss f igur es.
Royalty receipts ar e t axed on an accruals basis under DI or DVI.
Goodwill (which was pr eviously par t of t he capit al gains t ax r egime) will now only give r ise t o income gains or losses. Goodwill has ceased to be a qualifying asset for capital gains tax rollover. However , a form of rollover relief is available. The r ules apply t o goodwill bought or created after 1 April 2002.
For goodwill pur chased and ot her I FA asset s acquir ed or cr eat ed af t er 1 Apr il Par a 10 & 11 Sch 29 2002 t he company is allowed a deduction for the amortisation or impairment FA 2002 charged in t he account s. Alt er nat ively t hey can claim a straight line deduction of 4% on cost. I nt ernat ional Account ing St andard No 38 (I AS 38) does not allow a company t o amor t ise goodwill. Goodwill will be st at ed in t he balance sheet at f air value and subj ect t o an impair ment r eview.
When a company f ir st adopt s I AS 38 it may be r equir ed t o incr ease t he car r ying Par a 116A - value of goodwill. Schedule 29 ensur es t hat t he wr it e up is a t axable cr edit , 116B, 116F Sch 29 limited to the amount of relief already given. Any impairment from written up FA 2002 cost will be deduct ible.
Realisat ions of asset s r esult in income gains or losses, r ollover r elief may be available.
66 Principles of Business Taxat ion ‘Finance Act 2006’
A r ealisat ion is def ined as any t r ansact ion r esult ing in, in accor dance wit h gener ally accept ed account ing pr act ice,
(i) t he asset ceasing t o be r ecognised in t he company' s balance sheet ; or
(ii) a r educt ion in t he account ing value of t he asset , usually wher e only par t of t he asset is sold or ot her wise r ealised.
“Tr ansact ion” is def ined as including any event giving r ise t o a gain r ecognised f or account ing pur poses.
Proceeds of r ealisat ion ar e t hose r ecgonised f or account s pur poses less incident al cost s of r ealisat ion.
Wher e an asset has been wr it t en down f or t ax t he gain is t he dif f er ence bet ween t he pr oceeds and t he TWDV. I f no amount s have been wr it t en of f f or t ax t hen t he f ull cost may be br ought in.
I n t he case of a par t r ealisat ion The amount deducted is adjusted pro rata to t he account ing value at t r ibut able t o t he r ealisat ion and t he account ing value bef or e r ealisat ion.
B7.6 Rollover relief for IFAs Par a 37 Sch 29 FA 2002 I f an I FA is sold t hen any gain ar ising will be an income gain.
Illustration 1
A Lt d pur chased goodwill on 1 May 2005 f or £ 250,000 and sold it f or £ 300,000 on 31 December 2005. The company amor t ised t he goodwill at 10% per annum. I t s year end is 30 J une.
The amor t isat ion char ged f or t he 8-mont h per iod f or which t he company owned t he goodwill (1 May t o 31 December 2005) will be:
£ 250,000 x 10% x 8/ 12 = £ 16,667
The wr it t en down value of t he goodwill is: £ Cost 250,000 Less: amor t isat ion t o dat e (16,667) 233,333
I nt angible Fixed Asset s 67
The sale t akes place in t he account ing per iod ended 30 J une 2006 and t he income gain will be: £ Proceeds of sale 300,000 Less: WDV (233,333) Income gain 66,667
Wher e a company r einvest s t he pr oceeds of sale in ot her goodwill (or ot her I FA) Par as 39-41 Sch 29 it can claim r ollover r elief . The pr oceeds need t o be reinvest ed in t he period 12 FA 2002 months before to 36 months after t he sale of t he old I FA. To get full relief the whole of the proceeds need to be reinvested.
Illustration 2
Cont inuing t he example of Company A Lt d. The company buys r eplacement goodwill f or £ 400,000. All pr oceeds have been r einvest ed so r ollover r elief will be available in f ull.
The amount r olled over will be: £ Proceeds r einvest ed 300,000 Less: cost of old IFA (250,000) 50,000
Not e t hat we do not t ake account of t he amount s wr it t en of f t he cost in t his calculat ion. £ Income gain 66,667 Amount rolled over (50,000) 16,667
Following t he claim, t he company will st ill show a credit in it s P&L of £ 16,667 r epr esent ing a r ever sal of t he wr it e-of f .
The cost of t he new goodwill going f or war d will be: £ Cost of new I FA 400,000 Less: income gain r olled over (50,000) 350,000
I f only part of the proceeds are reinvested, t he amount available f or rollover Par a 41(3) Sch 29 is t he amount by which the amount reinvested exceeds the cost of the old FA 2002 asset.
Illustration 3
I f A Lt d above decides t o r einvest only £ 270,000, as t his is less t han t he pr oceeds r eceived, r elief will only be available f or: £ Amount r einvest ed 270,000
68 Principles of Business Taxat ion ‘Finance Act 2006’
Less: cost of old asset (250,000) 20,000
The gain f or t he year will be: £ Income gain 66,667 Amount rolled over (20,000) 46,667
The cost of t he new asset going f or war d will be: £ Cost of new I FA 270,000 Less: income gain r olled over (20,000) 250,000
Special r ules apply wher e t he asset sold was cr eat ed bef ore 1 April 2002. I FAs t hat exist ed bef or e t his dat e st ay wit hin t he capit al gains t ax r egime however t hey do not stay within the capital gains tax rollover relief rules.
On disposal t he asset will give r ise t o a capit al gain, f r om 1 Apr il 2002 t his gain can only be r olled over under t he r ules set down in t he FA 2002.
This is achieved by making cer t ain amendment s t o t he r ollover pr ovisions t hat we Par a 130 looked at above. Sch 29 FA 2002
The net pr oceeds r eceived (i.e. pr oceeds less incident al cost of disposal) ar e compared to cost. Cost is defined as net pr oceeds less t he char geable gain as calculat ed f or capit al gains t ax in ot her wor ds we include indexat ion allowance wher e applicable.
Illustration 4
X Lt d sells goodwill it has held since December 1990 f or £ 300,000 paying solicit or s f ees of £ 30,000 in r elat ion t o t he sale. The goodwill or iginally cost £ 55,000. I A is 20%. X Lt d is considering t he f ollowing invest ment s in a new I FA: a) £ 280,000 b) £ 220,000
The gain ar ising will be: £ Proceeds 300,000 Less: expenses (30,000) Net proceeds 270,000 Less: Cost (55,000) 215,000 IA £55,000 x 20% (11,000) Char geable gain £ 204,000 I nt angible Fixed Asset s 69
Under opt ion a) t her e will be f ull r einvest ment as t he new asset cost s £ 280,000 which is mor e t han t he net pr oceeds f or t he old asset of £ 270,000.
The gain t hat can be r olled over is £ 204,000 giving a base cost f or t he new asset of £ 280,000 - £ 204,000 = £ 76,000.
Under opt ion b) t her e will be par t ial r einvest ment . The new asset cost £ 220,000 which is less t han t he net pr oceeds r eceived of £ 270,000.
The gain t hat can be r olled over will be £ 220,000 - £ 66,000 = £ 154,000. This gives t he same r esult t o t hat which would have ar isen under t he CGT r ules wher eby net pr oceeds not r einvest ed r emain char geable.
The base cost of t he new asset will be £ 220,000 - 154,000 = £ 66,000.
B7.7 Groups Par as 46-54 Sch 29 FA 2002 For I FA pur poses, gr oups ar e essent ially t he same as t hose def ined f or capital gains pur poses. We examine t his def init ion in a lat er chapt er .
Tr ansf er s of I FAs wit hin a gr oup ar e tax neutral, pr ovided t hat t he asset is a char geable I FA bef or e and af t er t he t r ansf er .
Rollover is allowed on a group wide basis pr ovided t hat t he company t hat buys t he new asset is wit hin t he same gr oup at t he t ime of pur chase and is not a dual r esident invest ment company. I n addit ion t he new asset must be bought f r om out side t he gr oup.
Relief is also available wher e a company buys a cont r olling int er est in anot her Par a 57 company which holds I FAs. For t he pur poses of a r ollover claim t he pur chasing Sch 29 FA 2002 company is t r eat ed as buying t he under lying I FA at t he lower of : • t ax wr it t en down value; • cost of t he cont r olling int er est .
The pur chasing company can make a r ollover claim pr ovided it and t he company wit h t he under lying I FA sign t he claim. As a r esult t he TWDV of t he under lying asset will be wr it t en down t o t he ext ent of t he claim.
B7.8 Companies leaving a group Par a 58 Sch 29 FA 2002 Wher e a company leaves a group within six years of an IFA transfer and st ill holds t he I FA, it is t r eat ed as having t he sold and purchased the IFA at market value on the date of the transfer. The result ing debit or credit will be t r eat ed as arising immediately before the transferee leaves the group.
70 Principles of Business Taxat ion ‘Finance Act 2006’
Wher e a degr ouping char ge ar ises t he company about t o leave t he gr oup t oget her wit h anot her gr oup member can jointly elect to treat the degrouping charge or any part of it as arising in that other group company. The gain will be t r eat ed as a non-t r ade cr edit ar ising in t hat ot her company immediat ely bef or e t he f ir st company leaves t he gr oup.
Payment s wit hin t he gr oup in r elat ion t o r ollover or degr ouping char ges ar e not t axable so long as t hey do not exceed t he amount of t he r elief .
Not e: I t would be advisable t o look at t hese sect ions of t his chapt er again once you have complet ed all of t he chapt er s dealing wit h gr oups of companies.
Para 92-99 B7.9 Related Parties Sch 29 FA 2002
Ther e ar e r ules r elat ing t o t r ansact ions wit h r elat ed par t ies. The def init ion of a r elat ed Par t y is similar t o t hat used f or t r ansf er pr icing.
A r elat ed par t y can be a company, individual or ot her sor t of per son. Par t ies ar e r elat ed when:
• bot h par t ies ar e companies and one cont r ols t he ot her or has a maj or int er est in t he ot her ;
• bot h par t ies ar e companies and anot her per son cont r ols bot h of t hem (t his does not apply wher e bot h ar e cont r olled by a gover nment or an int er nat ional or ganisat ion);
• wher e t he company is a “close company”, a per son is r elat ed if t hey ar e a par t icipat or of t he company, or a par t icipat or in anot her company t hat has cont r ol of , or a maj or int er est in t he company; or
• (f or account ing per iods beginning aft er 19 J une 2003) bot h par t ies ar e companies and t hey ar e member s of t he same 75 per cent gr oup.
Tr ansact ion bet ween r elat ed par t ies must t ake place at mar ket value. Par a 92
Royalt ies t o r elat ed par t ies ar e deduct ed on a paid basis if not paid wit hin 12 Par a 94 mont hs of t he paying company’s per iod of account .
Rollover r elief cannot be claimed on t r ansact ions wit h r elat ed par t ies. Par a 93
Tr ansact ions wit h r elat ed par t ies cannot cr eat e new asset s f or t he pur poses of Par a 118 Sch 29 FA 2002. A pre 1 April 2002 I FA bought f rom a r elat ed par t y will st ay wit hin t he capit al gains t ax r ules.
I nt angible Fixed Asset s 71
B7.10 Commencement of the rules for IFAs
The legislat ion applies t o int angible f ixed asset s bought or cr eat ed f r om 1 Apr il 2002 onwar ds.
An asset bought or created partly before and partly after 1 April 2002 is treated as two assets. The expendit ur e on t he pur chase or cr eat ion of t he asset is appor t ioned on a j ust and r easonable basis.
I nt er nally gener at ed goodwill is t r eat ed as cr eat ed under t he old r ules if t he company car r ied on t he business bef or e 1 Apr il 2002.
The t r ansit ional r ules r elat ing t o r ollover r elief on asset s t hat st ay wit hin t he capit al gains t ax r ules ar e set out above.
72 Principles of Business Taxat ion ‘Finance Act 2006’
SUMMARY – INTANGIBLE FIXED ASSETS
Fr om 1 Apr il 2002 new r ules wer e int r oduced f or I nt angible Fixed Asset s (I FAs).
Debit s and cr edit s in r elat ion t o I FAs ar e t axed/ r elieved in line wit h t he account ing t r eat ment .
Amor t isat ion of an I FA is allowed or t he company can elect f or a 4% st r aight line wr it e of f .
Royalt ies ar e br ought in on an accr uals basis f or t ax f ollowing t he account s.
Debit s and cr edit s r elat ing t o I FAs ar e DI or DVI depending on whet her t hey r elat e t o t he t r ade.
Non-t r ade debit s and cr edit s go t o a DVI pool. I f t her e is a net def icit t his can be set of f in t he cur r ent year against ot her income, gr oup r elieved or car r ied f or war d.
Disposals of I FAs such as goodwill give r ise t o an income gain or loss however , a f or m of r ollover r elief is available.
Tr ansf er s of I FAs in a CGT gr oup ar e t ax neut r al. A degr ouping char ge can ar ise f ollowing t he t r ansf er of an I FA. This degr ouping char ge can be t r ansf er r ed t o anot her company. Group wide r ollover is possible f or I FAs.
Tr ansact ions wit h r elat ed par t ies ar e t r eat ed as t aking place at mar ket value.
Late paid royalties (more than 12 months f r om t he end of an account ing per iod) t o r elat ed par t ies will be deduct ible on a paid basis.
B8: RESEARCH AND DEVELOPMENT EXPENDITURE
This chapt er will out line t he r elief available f or expendit ur e on r esear ch and development , cover ing in par t icular : - t he 150% t ax r elief available t o small and medium sized companies; - t he t ax cr edit s available t o loss making small and medium sized companies; - t he 125% t ax r elief available t o lar ge companies.
B8.1 Introduction
This r elief was or iginally int r oduced f or small and medium sized companies by Finance Act 2000. Not e t hat t he r elief is not available t o t r ader s – only t o companies.
The r elief has now been extended and improved by subsequent Finance Act s t o include relief f or large companies and f or wor k subcontracted to small and medium companies
Usef ul guidance can be f ound in t he legislat ion in t he Miscellaneous Non St at ut or y Mat er ial, Number I X.
B8.2 Definition of R&D
The legislat ion def ines r esear ch and development (R&D) as act ivit ies t hat f all t o s.837A
be t r eat ed as R&D in accor dance wit h generally accepted accounting practice. SI 2004/ 712 Thus we need to look at SSAP 13 (I AS 38) f or t he def init ion. This def init ion is Misc I t hen modif ied by guidelines and t he lat est of t hese wer e published in Mar ch 2004.
SSAP 13 dist inguishes R&D act ivit y f r om non-r esear ch act ivit y by t he t est of whet her t her e is presence of an appreciable element of innovation. I f the act ivit y depar t s f r om r out ine and br eaks new gr ound it is normally included; however , if it f ollows an est ablished pat t er n it is nor mally excluded.
The f ollowing act ivit ies are nor mally included wit hin t he def init ion of R&D: (a) exper iment al, t heor et ical or ot her wor k aimed at t he discover y of new knowledge, or t he advancement of exist ing knowledge; (b) sear ching f or applicat ions of t hat knowledge; (c) f or mulat ion and design of possible applicat ions f or such wor k; (d) t est ing in sear ch f or , or evaluat ion of , pr oduct , ser vice or pr ocess alt er nat ives; 74 Principles of Business Taxat ion ‘Finance Act 2006’
(e) design, const r uct ion and t est ing of pr e-pr oduct ion pr ot ot ypes and models and development bat ches; (f ) design of pr oduct s, pr ocesses, ser vices or syst ems involving new t echnology or subst ant ially impr oving t hose alr eady pr oduced or inst alled; (g) const r uct ion and oper at ion of pr ot ot ypes and pilot plant s.
Wor k on t he per iodic updat ing or modif icat ion of a pr oduct is not R&D if it does not involve an appr eciable element of innovat ion and does not br eak new gr ound. A pr ogr amme of R&D may however r esult in incr ement al impr ovement s t o a pr oduct , ser vice or pr ocess.
B8.3 Small and medium sized companies
A company incur r ing qualif ying Resear ch and Development (R&D) expendit ur e will Par a 13 Sch 20 be able t o claim a deduction equal to 150% of the costs incur r ed in calculat ing FA 2000 it s PCTCT.
The usual ef f ect of this is that the further 50% of t he R&D expendit ur e needs t o be deducted in arriving at the adjusted profits for tax purposes.
Illustration 1
Small Limit ed spends £ 65,000 on qualif ying R&D in it s account ing per iod ended 31 December 2006.
I n calculat ing PCTCT f or t he year t o 31 December 2006 t he t ot al deduct ion f or R&D will be:
£ 65,000 x 150% = £97,500
I f t he £ 65,000 has already been deduct ed in ar r iving at t he account ing pr of it , t his means t hat an addit ional deduct ion of
(£ 97,500 - 65,000) = £32,500 i.e. 50% of £ 65,000
should be put t hr ough as an adj ust ment in ar r iving at t he pr of it s f or t ax pur poses.
To qualif y f or t he r elief t he company must spend £10,000 on qualif ying R&D. Par a 1 Sch 20 FA 2000
This f igur e is f or a 12 month accounting period and will be pr opor t ionally r educed wher e t he account ing per iod is less t han 12 mont hs e.g. f or a six mont h period t he limit will be £ 5,000.
Resear ch and Development Expendit ur e 7 5
To qualify as a small or medium sized enterprise (SME) t he company must have: Par a 1 Sch 20 (i) f ewer t han 250 employees; and FA 2000 (ii) eit her annual t ur nover of less t han 50m Eur os or an annual balance sheet t ot al of less t han 43m Eur os.
These limit s ar e in your Tax Tables.
B8.4 Qualifying R&D
Cer t ain condit ions have t o be met in r elat ion t o t he expendit ur e: Par a 3 Sch 20 (i) it must be revenue not capital in nat ur e; FA 2000
(ii) it must be related to a trade carried on or to be carried on by the company; (iii) it must be incur r ed on: (a) staff costs; (b) software; (ba) relevant payments to the subjects of clinical trials; (c) consumable or transformable materials; (d) subcontracted R & D costs; or (e) externally provided workers. (iv) Any intellectual property cr eat ed as a r esult of t he expendit ur e must vest in the company; (v) I t is not incurred in t he car r ying on of activities which are contracted out t o t he company by any per son (alt hough under FA 2002 t hese r ules have been ext ended in cer t ain cir cumst ances - we will look at t his lat er );
(vi) I t is not subsidised, (alt hough an SME is allowed a 25% enhanced deduct ion on ‘subsidised’ expendit ur e pr ovided it would be available t o a lar ge company in t he same cir cumst ances).
B8.5 Staff costs
St af f cost s compr ise: Par a 5 (i) all emoluments of what ever nat ur e paid out t o t he dir ect or s or employees Sch 20 ot her t han benef it s in kind; FA 2000
(ii) secondary class one NIC paid by t he company; (iii) cont r ibut ions t o pension f unds paid by t he company f or t he benef it of dir ect or s and employees.
Only st af f ing cost s f or dir ect or s and employees directly and actively involved in R&D will qualif y. Wher e someone is partly engaged in R&D, t heir t ime is apportioned so t hat only st af f ing cost s incur r ed on R&D act ivit ies can be included. The cost of st af f who pr ovide support to R&D staff do not qualify, f or example secr et ar ies or administ r at ive st af f .
76 Principles of Business Taxat ion ‘Finance Act 2006’
B8.6 Software
Qualif ying expendit ur e is t hat which is incur r ed on sof t war e t hat is employed dir ect ly in car r ying out t he R&D, f or example t o r ecor d r esult s. The cost of sof t war e used indir ect ly, f or example t hat used by t he human r esour ces depar t ment t o r ecor d t he act ivit ies of t he R&D st af f , would not qualif y. Wher e only par t of t he cost incur r ed r elat es dir ect ly t o R&D a pr opor t ion of t he cost will be allowable.
B8.7 Consumable or transformable items
Qualif ying expendit ur e is t hat which is incur r ed on r evenue it ems dir ect ly employed in R&D. This includes consumable st or es t oget her wit h wat er , f uel and power of any kind. Wher e only par t of t he cost incur r ed r elat es dir ect ly t o R&D a pr opor t ion of t he cost will be allowable.
B8.8 Relevant payments to subjects of clinical trails Par a 6A Sch 20 FA 2000 Relevant payment s mean payment s f or par ticipat ing in t he t rials. A clinical t rial is an invest igat ion in human subj ect s under t aken in connect ion wit h t he development of a healt h car e t r eat ment or pr oduct .
For lar ge companies, expendit ur e on or af t er 1 April 2006 qualif ies. The dat e f or SMEs will be announced by st at ut or y instr ument but will not be ear lier t han 1 April 2006.
B8.9 Sub-contracted R & D
Wher e t he SME subcont r act s R&D wor k t o a t hir d par t y, t he SME may claim Par a 9 r elief . The t r eat ment var ies depending on whet her t he t wo par t ies ar e connect ed. Sch 20 FA 2000
Wher e t he payment is t o a connected company, which dr aws it s account s up under Par a 10 Sch 20 GAAP, t he whole of any payment up t o t he amount of t he connect ed company’s FA 2000 expendit ur e is allowable.
In any other case 65% of the payments made can be claimed. However a joint Par a 11 & 12 Sch 20 irrevocable election can be made f or connected company treatment. The t ime FA 2000 limit f or t he elect ion is t wo year s f r om t he end of t he f ir st account ing per iod in which t he cont r act is ent er ed int o.
B8.10 Externally provided workers
Wher e a company makes a payment t o anot her per son f or t he pr ovision of Par a 8A wor ker s, sever al condit ions apply in order t o get r elief f or t he payment . An Sch 20 ext er nally pr ovided wor ker must : FA 2000 (i) be an individual; (ii) not be also a dir ect or or employee of t he company; Resear ch and Development Expendit ur e 77
(iii) be obliged t o pr ovide ser vices t o t he company per sonally; (iv) be under t he cont r ol of t he company.
As wit h t he company’s own st af f , t he ext er nally pr ovided wor ker s must be directly and actively involved in R&D. Secr et ar ial and administ r at ive ser vices ar e specif ically excluded.
Wher e a wor ker is par t ly engaged in R&D, t he expendit ur e must be appor t ioned.
I f t he ext er nally pr ovided wor ker s ar e not provided by a connected company Par a 8E & 8D Sch 20 65% of t he payment made will be qualif ying expendit ur e. However , t he company FA 2000 and t he st af f pr ovider can jointly elect in writing for the connected company rules to apply. The election is irrevocable and must be made wit hin two years f r om t he end of t he f ir st account ing per iod in which t he cont r act is ent er ed int o.
Wher e t he wor ker s ar e pr ovided by a connect ed company and t hat company Par a 8C dr aws up it s account s in accor dance wit h GAAP t hen t he whole of t he payment up Sch 20 FA 2000 t o t he st af f pr ovider ’s cost of t he wor ker s can be claimed.
B8.11 R&D Tax Credits
This r elief allows companies wit h t r ading losses t o “surrender” part of t hat loss t o t he gover nment in r et ur n f or a t ax r ef und.
A company wit h a t r ading loss t hat has incur r ed qualif ying R&D can sur r ender all or par t of t he loss as f ollows.
Firstly the surrenderable amount needs t o be calculat ed. This is t he lower of: Par a 15 Sch 20 (i) the unrelieved trading loss; and FA 2000 (ii) 150% of the qualifying R&D expenditure.
For t hese pur poses an unr elieved t r ading loss means t he trading loss of the per iod reduced by any actual and potential claims for relief for that loss in the current period and any ot her act ual loss r elief claims made in r espect of t he loss.
No account is t aken of losses brought forward or carried back to t his account ing per iod.
Once t his loss has been sur r ender ed t he amount of credit given is the lower of: Par a 16 Sch 20 (i) 16% of t he sur r ender able loss f or t he per iod; and FA2000 (ii) t he company’s PAYE and NIC bill f or t he per iod.
78 Principles of Business Taxat ion ‘Finance Act 2006’
Illustration 2
Medium Lt d has t he f ollowing r esult s:
Tr ading loss £ 170,000 Qualifying R&D £45,000 PAYE/NIC bill £85,000
The sur r ender able loss is t he lower of : (i) £ 170,000 (ii) £ 45,000x 150% = £ 67,500
i.e. £ 67,500
The t ax cr edit given will be t he lower of
(i) 16% x £ 67,500 = £ 10,800 (ii) £ 85,000
i.e. £10,800
This t ax credit of £ 10,800 will eit her be used t o r educe Medium Lt d ‘s t ax bill if it has ot her sour ces of income or will be r eceived as a t ax f r ee r ef und.
The t r ading loss of t he company car r ied f or war d is now:
£ 170,000 - £ 67,500 = £ 102,500
For expendit ur e of £ 45,000 t he company has r eceived a r ef und of £ 10,800 which equat es t o 24% (10,800/ 45,000) or 150% x 16% = 24%.
Illustration 3
Raf ael Lt d, a small company, spends £ 125,000 on qualif ying R&D. The company has a t r ading loss of £ 135,000 and has DI I I income of £ 40,000. The company’s PAYE/ NI C bill of £ 67,000.
The sur r ender able loss is t he lower of : (i) £ 135,000 less t he £ 40,000 pot ent ial CY loss claim i.e. £ 95,000 (ii) £ 125,000 x 150% = £ 187,500
i.e. £ 95,000
The t ax cr edit given will be t he lower of (i) 16% x £ 95,000 = £ 15,200 (ii) £ 67,000
i.e. £15,200 Resear ch and Development Expendit ur e 79
B8.12 Large Companies Sch 12 FA 2002
Lar ge companies qualif y f or R&D r elief f or accounting periods ending on or after 1 April 2002.
Lar ge companies ar e t hose t hat do not qualif y as SMEs under t he r ules above.
The r elief given t o lar ge companies is a 125% deduction in calculat ing PCTCT. Par a 11 Sch 12 The usual ef f ect of t his is t hat t he further 25% of t he R&D expendit ur e needs FA 2002 t o be deducted in arriving at the adjusted profits for tax purposes.
Illustration 4
Lar ge Limit ed spends £ 245,000 on R&D dur ing t he account ing per iod ended 31 March 2007.
The deduct ion in calculat ing t he PCTCT will be:
£ 245,000 x 125% = £ 306,250
I f t he £ 245,000 has already been deduct ed in ar r iving at t he account ing pr of it , t his means t hat an addit ional deduct ion of
(£ 306,250 - 245,000) = £61,250 i.e.25% of £ 245,000
should be put t hr ough as an adj ust ment in ar r iving at t he pr of it s f or t ax pur poses.
The def init ion of r esear ch and development is t he same as t hat which is applied t o small and medium sized ent er pr ises.
To qualif y f or t he r elief t he company has t o spend a minimum of £10,000 dur ing t he account ing per iod. This limit is again pr o r at ed f or account ing per iods of less t han t welve mont hs.
A lar ge company can claim for expenditure on work contracted to it provided it Par a 4 is cont r act ed by anot her lar ge company or any per son ot her wise t han in t he Sch 12 FA 2002 cour se of a t r ade char geable t o Schedule D Cases I or I I .
No r elief can be claimed wher e wor k is subcont r act ed t o a lar ge company by an SME as t he SME will claim relief .
Ther e is no requirement for the intellectual property creat ed by t he R&D to vest in t he company.
80 Principles of Business Taxat ion ‘Finance Act 2006’
B8.13 Subcontracted R&D
Lar ge companies will be able t o claim relief for R&D subcontracted to others Par a 5 and on cont r ibut ions t o independent r esear ch and development so long as it is Sch 12 expendit ur e incur r ed in making payment s t o qualifying bodies being: FA 2002 • Univer sit ies; • Char it ies; • Scient if ic r esear ch or ganisat ions; • NHS bodies; and • I ndividuals or par t ner ships.
Relief of 125% can be claimed by an SME f or R&D subcont r act ed t o it so long Par a 7 as it s t ot al expendit ur e (it s own plus subcont r act ed) on R&D f or t he account ing Sch 20 FA 2000 per iod exceeds £ 10,000. This is r educed f or account ing per iods of less t han 12 mont hs.
The wor k has t o be subcont r act ed t o t he SME by a lar ge company or any ot her per son not t axable under Schedule D Cases I or I I .
The SME can claim f or expendit ur e on wor k directly undertaken itself or for expendit ur e wher e t he wor k is under t aken by ot her s on behalf of t he SME so long as t he payment s ar e t o qualif ying bodies as f or lar ge companies above or individuals/ par t ner ships.
B8.14 Vaccine Research Sch 13 FA 2002 A similar r elief is available f r om 22 Apr il 2003 f or companies car r ying out r esear ch int o cer t ain vaccines and medicines (TB, Malar ia, HI V and AI DS).
For large companies t he deduct ion is 150% wit h no ot her par t icular condit ions Par a 21 applying i.e. no £ 10,000 limit et c. Sch 13 FA 2002
For SMEs t he r elief is a deduct ion of 150% of t he cost incurred if t hey do not Par a 14 Sch 13 qualif y f or R&D r elief and a further 50% (i.e. 200% in t ot al) deduct ion if t hey do FA 2002 so qualif y.
The amount claimable can be included in a t ax credit claim by t he SME.
B8.15 Claims for Research and Development relief. Part 9A t o 9C Sch 18 FA 1998
For account ing per iods ending on or af t er 31st March 2006 all claims f or R&D t ax cr edit s and enhanced deduct ions will need t o be made wit hin t he company’s t ax r et ur n.
Resear ch and Development Expendit ur e 81
Par agr aphs 83A t o 83E of Sch 18 FA 1998 ar e amended t o include all R&D r elief claims, not j ust t ax cr edit claims. Similar r ules have been added f or lar ge company claims and vaccine r elief .
The r ules r elat ing t o penalt ies in Par a 83F Sch 18 FA 1998 remain specif ic t o t ax cr edit s. Claims f or enhanced deduct ions will be cover ed by t he nor mal penalt y r egime f or f r audulent or negligent r et ur ns.
For account ing per iods ending af t er 31 Mar ch 2002 but bef ore 31 March 2006 all claims must be amended or wit hdr awn by 31 Mar ch 2008.
Previously t her e wer e only specif ic r ules r elat ing t o R&D t ax cr edit s but none r elat ing t o t he enhanced r elief which meant t hat the six year t ime limit f rom t he end of t he account ing per iod applied.
Example 1
Lamp Lt d, a small company, spends £ 35,000 on R&D dur ing t he year t o 31 Mar ch 2007. Prof it s bef or e R&D deduct ions ar e £ 155,000.
You ar e r equir ed t o calculat e t he PCTCT
Example 2
Net Lt d, a small company, spends £ 150,000 on R&D. Dur ing t he year t he company makes a t r ading loss of £ 70,000 and had a PAYE/ NI C bill of £ 35,000.
You ar e r equir ed t o calculat e t he amount of t ax cr edit t he company may claim.
82 Principles of Business Taxat ion ‘Finance Act 2006’
Answer 1
£ Prof it s 155,000 Less R&D 35,000 x 150% (52,500) PCTCT £102,500
Answer 2
The sur r ender able loss will be t he lower of :
£ Unr elieved loss 70,000 150% x 150,000 225,000 Theref ore 70,000
The t ax credit will be t he lower of
16% x 70,000 11,200 The NIC/PAYE bill = 35,000
Theref ore t he t ax credit will be £11,200 Resear ch and Development Expendit ur e 83
SUMMARY – RESEARCH AND DEVELOPMENT EXPENDITURE
R&D r elief of 150% is available t o SMEs.
The r elief r elat es t o r evenue expendit ur e on sof t war e and consumable it ems, r elevant payment s t o subj ect s of clinical t r ials, st af f cost s, sub-cont r act ed R&D cost s and ext er nally pr ovided wor ker s.
I n t he case of payment s t o connect ed companies all t he cost s qualif y f or r elief . For subcont r act ed R&D and ext er nally pr ovided wor ker payment s t o unconnect ed companies, only 65% of t he cost can be claimed unless an elect ion is made f or connect ed par t y t r eat ment .
SMEs wit h losses can sur r ender t hem t o t he Revenue and r eceive a t ax cr edit / r epayment .
The sur r ender able amount is t he lower of : Qualif ying R&D x 150% Unr elieved t r ading losses
The t ax credit will be t he lower of : Sur r ender ed amount x 16% The company’s PAYE/ NI C bill
Lar ge companies can claim a t ax deduct ion of 125% f or qualif ying R&D.
Similar r elief is available f or expendit ur e on vaccine r esear ch.
Par as 9A, 9BA and 9C of Sch 18 FA 1998 set down t he r ules f or making claims.
B9: TAX LAW AND ACCOUNTING PRACTICE
This chapt er looks at t he int er act ion of t ax law and account ancy pr act ice cover ing in par t icular : - t he impor t ance of GAAP; - Herbert Smit h V Honour; - t he r ecognit ion of income.
B9.1 General principle
I n gener al t he t ax t r eat ment of a par t icular it em will f ollow t he account ing t r eat ment , i.e. income shown in t he P & L Account is t axable and expenses ar e deduct ible. This pr inciple applies unless t ax legislat ion or case law dict at es ot her wise. This pr inciple has been ar ound f or year s as t he st ar t ing point f or t he measur e of pr of it t axable under Schedule D Case I . However , r ecent legislat ive changes have act ually made t he account ing r ules apply f or t ax pur poses in many cases.
I n Finance Act 1993 t he f or eign exchange gains and loss r ules f or t ax pur poses wer e aligned wit h t he account ing t r eat ment . Finance Act 1994 r equir ed t he r ecognit ion of gains and losses under t he f inancial inst r ument s r ules t o f ollow t he account ing t r eat ment . This was f ollowed in Finance Act 1996 which applies t he account ing t r eat ment t o all loan r elat ionships, namely her e t he t ax t r eat ment of int er est .
The Gover nment went vir t ually t he whole way t owar ds aligning t ax and account ing in s.42 of t he Finance Act 1998 which r equir es all account s t o be pr epar ed using t he t r ue and f air basis. This ef f ect ively r emoved t he cash basis f or t he r ecognit ion of income f or all businesses and companies.
Recently we have seen many changes in t he r ules t o deal wit h t he adopt ion of int er nat ional account ing st andar ds (I AS). Most not ably GAAP is now def ined as including int er nat ional account ing st andar ds. The t er minology used in st at ut e has been amended to follow that used in IAS. For example, references to bad debt relief have been r eplaced wit h r ef er ences t o impair ment losses.
B9.2 Accounting standards
As t he t ax t r eat ment , in many cases, is dict at ed by t he account ing t r eat ment , it is impor t ant t o ensur e t he pr oper adopt ion of accounting standards. The tax t r eat ment should f ollow gener ally accept ed account ing pr inciples or GAAP as it is commonly shor t ened t o. For account ing per iods beginning on or af t er 1 J anuar y 2005 t he def init ion of GAAP is ext ended t o include adher ence wit h I nt er nat ional Account ing St andar ds (I AS) wher e r equir ed. The need t o f ollow GAAP has been developed bot h in legislat ion by s.42 Finance Act 1998 and in case law.
Tax Law and Account ing Pract ice 85
I n t he case of Gallagher v Jones, a company ent er ed int o a f our year f inance lease wit h lease r ent als ar e payable over t his f our year per iod. The r ent act ually paid was £ 397 in year 1 and a pepper cor n r ent i.e. £ 1 p.a. f or t he r emainder of t he lease and t his was t he t r eat ment which was adopt ed in t he account s.
However , under SSAP21 t he cor r ect account ing t r eat ment should r ecognise the economic r ealit y of t he t r ansact ion. The asset is being leased f or a f our year period at an overall cost of £400, so t her ef or e t he cor r ect account ing t r eat ment is t o r ecognise t he cost evenly over t he per iod of t he lease as £ 100 per annum.
The Revenue disput ed t he account ing t r eat ment and put f or war d t he view t hat t her e is no r ule in t ax law st at ing t hat expenses ar e deduct ible when t hey ar e paid. The company was, t hr ough t he account ing t r eat ment , giving it self an up- f r ont t ax deduct ion t o which t he Revenue obj ect ed.
It was held in this case that the t ax t r eat ment should f ollow GAAP. Consequent ly t he Revenue can successf ully r equest t hat pr oper account ing pr inciples ar e applied, at least in t he t ax comput at ions, even if t he it em is not mat er ial t o t he account s.
The decision in t he Gallagher v Jones case r einf or ced SP 3/ 91 which r equir es t he t ax t r eat ment of f inance leased asset s t o f ollow cor r ect account ing t r eat ment .
B9.3 Importance of GAAP
Gener ally accept ed account ing pr inciples ar e ver y impor t ant when it comes t o calculat ing t axable pr of it s. I f t he cor r ect account ing pr inciples have been f ollowed t he Revenue cannot disput e t he t r eat ment unless st at ut e or case law st at es ot her wise. For inst ance, st at ut e st at es t hat ent er t aining expenses ar e disallowed f or t ax pur poses. This par t icular pr inciple was est ablished par t icular ly in t he case of Johnston v Britannia Airways.
Br it annia Air ways f ly a f leet of aer oplanes. Br it annia mat ched t he cost s of over hauling t he j et engines t o t he act ual f lying hour s t he f leet had f lown dur ing t he year .
The Revenue disput ed t his pr ovision, basically saying it did not relat e t o t he cost s act ually incur r ed, but t o cost s which may have been t heor et ically incur r ed. They want ed t he company t o f ollow t he accr uals met hod of account ing by br inging f or war d an accr ual f r om t he pr evious year , account ing f or t he expenses act ually incur r ed dur ing t he account ing per iod and accr uing f or expendit ur e commit t ed t o by t he end of t he year .
However , in t he j udgement t o t his case it was held t hat what Br it annia was doing was per f ect ly accept able under gener ally accept ed account ing pr inciples. The Cour t did not f ollow t he ar gument put f or war d by t he Revenue t hat somet hing else might have been mor e accept able.
86 Principles of Business Taxat ion ‘Finance Act 2006’
Ther ef or e, t he conclusion t hat we can draw f r om t his case is wher e t her e is a choice as to how we apply a particular standard, t he choice rests with the tax paying company. We only need t o prove what we have done is acceptable. I t is not f or t he Revenue t o ar gue t hat somet hing else might be mor e accept able.
Unf or t unat ely FRS 12 which deals specif ically wit h t he account ing f or pr ovisions, has effectively prohibited a “Britannia style” provision in the future. Br it annia would now need t o show t hat t hey have a pr esent day obligat ion t hat is eit her cont r act ual or legal, bef or e t hey could provide f or t he over haul cost s in t his way. This is examined in t he next chapt er .
B9.4 Herbert Smith v Honour (1999)
Herbert Smit h is a solicit ors pract ice. They opened up of f ice number one in cent r al London and soon expanded t heir oper at ions t o a second sit e. They expanded again and opened up a t hir d and a f our t h of f ice, all in cent r al London.
I t was becoming logist ically dif f icult t o r un t he pr act ice f r om f our separ at e locat ions and consequent ly t hey made t he decision t o t ake out a lease on new lar ger pr emises, of f ice f ive and moved ever yt hing under t he same roof . All t his happened back in December 1990, t his dat e being ver y impor t ant f or what was happening in t he economy at t he t ime.
The leases on of f ices one, t wo, t hr ee and f our wer e t aken out by t he f ir m in t he lat e 1980s when land pr ices, par t icular ly in cent r al London, wer e ver y high and t her ef or e t hey had commit t ed t hemselves t o oner ous r ent al payment s. I n December 1990 when t hey moved int o sit e f ive, r ent al values on t hese pr oper t ies had f allen consider ably. As t heir landlor ds would not let t hem r elinquish t he leases, t he only opt ion t hat t hey had was t o sub-let t he pr emises unt il t he head leases expired. As a result of this sub-let t ing, losses in excess of £ 5½ million would be cr eat ed and t he f ir m pr ovided f or t he f ull amount in t he 1990 account s.
The Revenue sought t o disallow t his pr ovision. They quot ed SP 3/90 which basically says t hat we ar e not allowed t o ant icipat e losses f or t ax pur poses. Their ar gument was t hat t he f ir m should have accr ued f or t he r ent al losses over t he per iod t hat t he head leases expir ed. The f ir m disagr eed as t hey ar gued t hat what t hey had done was consist ent wit h t he concept of pr udence. SSAP 2 specif ically says t hat t he pr udence concept over r ides t he accr uals concept .
Consequent ly when t he case came bef or e t he High Court t he J udge ruled in favour of the firm on t he basis t hat t hey could pr ove what t hey had done was accept able on account ing gr ounds. As a r esult t he Revenue wer e f or ced t o wit hdraw SP 3/ 90.
Tax Law and Account ing Pract ice 87
B9.5 Review of the main accounting policies
The recognition of income
Cur r ent ly we f ollow t he pr udence and mat ching r ules, i.e. gener ally accept ed account ing pr inciples. However , a new f inancial r epor t ing st andar d (FRS) is t o be issued shor t ly and once t his is applicable, we must f ollow it , not only f or account ing pur poses, but also f or t ax pur poses.
If we fail to apply this new FRS the Revenue can ar gue successf ully, as given by t he Gallagher v J ones, case that we have not applied gener ally accept ed account ing pr inciples.
St ock
St ock valuat ion is given under SSAP 9. This af f ect s t he pr of it f igur e, but of cour se, we have a choice as t o how we value st ock and pr ovided t hat what we do is accept able, i.e. we f ollow SSAP 9 t her e is not hing t he Revenue can do t o challenge t he f igur es.
Provisions
The t r eat ment of pr ovisions is given under FRS 12. This is cover ed in t he next chapt er .
Many disput es wit h t he Revenue may cent r e on t he int er pr et at ion and applicat ion of account ing st andar ds, as we have seen f r om t he t hr ee cases r ef er r ed t o alr eady. Ther ef or e, t he Revenue ar e making incr easing use of account ant s, bot h in t heir invest igat ions t eam and as exper t wit nesses in t ax appeal hear ings.
B9.6 Materiality
The concept of materiality is not recognised by the Revenue. For t ax pur poses all t he f igur es in t he account s must be examined, not j ust t he mat er ial ones, as t he f ailur e t o apply gener ally accept ed account ing principles is likely t o lead t o an adj ust ment being r equir ed.
For inst ance, let us say t hat we r eceived a let t er f r om t he Revenue asking us t o conf ir m whet her a par t icular pr ovision meet s t he r equir ement s of FRS 12. When we open up t he audit f ile we r ealise t hat we did not make any comment s dur ing t he audit on t his par t icular pr ovision as it is immat er ial t o t he account s. Unless we can put f or war d suf f icient evidence to show that we have applied FRS12 cor r ect ly t he Revenue have ever y r ight t o ask f or an adj ust ment t o be made in t he t ax comput at ion.
88 Principles of Business Taxat ion ‘Finance Act 2006’
B9.7 GAAP and the FRSSE
The Revenue will accept accounts prepared under the Financial Reporting Standards for Small Enterprises (FRSSE) and cannot insist t hat a non-FRSSE st andar d is applied in a par t icular sit uat ion as t he account s as submit t ed f or t hat size of or ganisat ion have f ollowed t he cor r ect account ing t r eat ment and t her ef or e it cannot be challenged.
A company may choose not t o adopt FRSSE, in ot her wor ds t o adopt t he f ull array of standards. The Revenue’s view on this is that if a company chooses to apply one par t icular st andar d which is not applicable t o t he FRSSE, t hey must apply all of the other standards and must do so in full. This view is yet to be challenged.
B9.8 Capital and revenue
The Revenue believe t hat t he accounting treatment cannot change the nature of an item, be it capital or revenue. This view is expr essed in t heir bi-mont hly publicat ion Tax Bulletin, issue 39.
I s t his cont r ar y t o t he pr inciple est ablished in t he Herbert Smit h case?
S.72 ICTA 1988 disallows capital expenditure specifically.
S. 74(f), disallows expenditure which provides an enduring benefit to the business. This has been subj ect t o plent y of int er pr et at ion bef or e t he Cour t s.
S. 74(g) disallows the costs of improvement to business premises.
Consequent ly, t he Revenue can r ely on separ at e st at ut or y r ules so one can legit imat ely say t hat t his is not cont r ary t o t he Herbert Smit h principle which only r equir es t he account ing t r eat ment t o be f ollowed if t ax st atute or case law is silent on t he mat t er .
B9.9 Income recognition
The cr it ical ar ea f or t ax pur poses is t he r ecognit ion of income. Ther e is cur r ent ly no account ing st andar d dealing wit h t he r ecognit ion of income f or account ing or indeed t her ef or e t ax pur poses. However , wher e t he Revenue can show that GAAP have not been followed in r ecognising income in t he account s, t hey can successf ully r equest t he appr opr iat e adj ust ment .
This was given in t he decision in t he Gardner Mountain case. I n this particular case, insur ance commission agent s sold policies and wer e ent it led t o an amount of commission which was paid t o t hem at t he t ime t he policy was sold. However , if t he policyholder cashed t he policy in wit hin t he f ir st t wo year s some of t hat commission may have t o be r ef unded back t o t he insur ance company. The insur ance company, Gar dner Mount ain, advised all of t heir agent s t o account f or t he commissions income t o t he Revenue as f ollows:
Tax Law and Account ing Pract ice 89
• 50% in Year 1 • 25% in Year 2 • 25% in Year 3
The ar gument being t hat at t he t ime t he commission is act ually paid t o t hem there is a risk some of it will have to be r ef unded and t her ef or e it would be wr ong t o r ecognise all of it f or t ax pur poses up f r ont .
However , t he Revenue successf ully ar gued t hat t his t reat ment did not accord wit h t he under lying economic r ealit y of t he t r ansact ion. For t ax pur poses, t he Revenue were of the view that all of t he commission should be br ought int o char ge in t he account ing per iod in which it is r eceived, as it is t his account ing per iod in which t he wor k has been done t o sell t he policy.
I n t he second and t hir d year s t he Revenue would accept an expense of any commissions which t he agent subsequent ly has t o r ef und. I n some sit uat ions, a pr ovision might be accept able, but of cour se nowadays we would need t o f ollow FRS 12.
B9.10 Moving towards IAS
As st at ed above, f or account ing per iods beginning on or af t er 1 J anuar y 2005, compliance wit h GAAP includes compliance wit h I nt er nat ional Account ing St andar ds (I AS). The main dif f er ence bet ween t he GAAP and I AS is t he t endency t owar ds f air value account ing.
I AS concent r at e mor e on t he balance sheet and r ecognising movement s in t he opening and closing balance sheet wit hin t he pr of it and loss account . I AS pr ovide f or r ecognit ion of ant icipat ed pr of it s. Accr uals and pr udence ar e st ill t he basis f or account ing however t her e is gr eat er use of f air value account ing. Wher e t her e is a conf lict bet ween pr udence and f air value, f air value will pr evail.
I n amending t he legislat ion, in par t icular t hat r elat ing t o loan r elat ionships and der ivat ives, t o deal wit h I AS t he Revenue have lef t t hemselves t he r ight t o issue r egulat ions r equir ing t hat amount s r ecognised under GAAP ar e not br ought in f or t ax and vice ver sa giving specif ic r ules on how t hese amount s will be dealt wit h f or tax.
We have seen an example of t hese r ules in t he chapt er on loan r elat ionships.
For account ing per iods beginning on or af t er 1 J anuar y 2005, wher e in a gr oup of s.51 FA2004 companies one company uses I AS and anot her UK GAAP, t hen if t here are t r ansact ions bet ween t he t wo and a t ax advant age would ar ise as a r esult of t he dif f er ent account ing policies, t hey ar e bot h t o be t r eat ed as using UK GAAP.
A gr oup f or t hese pur poses is as def ined f or capit al gains t ax.
90 Principles of Business Taxat ion ‘Finance Act 2006’
SUMMARY – TAX LAW AND ACCOUNTING PRACTICE
The Revenue is looking mor e and mor e t owar ds Account ing St andar ds t o det er mine t he t ax t r eat ment of income and expendit ur e.
GAAP is ver y impor t ant . I f t he cor r ect account ing t r eat ment has been f ollowed t he Revenue cannot disput e t he t r eat ment unless st at ut e or case law st at es ot her wise.
Following t he Her ber t Smit h case, which looked at t he pr ovision f or losses on a lease, t he Revenue had t o wit hdr aw SP 3/ 90 which pr ohibit ed ant icipat ion of losses.
Ther e is cur r ent ly no account ing st andar d dealing wit h t he r ecognit ion of income. However if t he Revenue can show t hat GAAP has not been f ollowed t hey can r equest t he appr opr iat e adj ust ment as t hey did in t he Gar dner Mount ain case.
The inclusion of I AS in GAAP will r esult in a move t owar ds f air value account ing and r ecognising movement s in balance sheet values. The Revenue have t he r ight t o issue r egulat ions r equir ing amount s r ecognised f or GAAP t o be adj ust ed in t he t ax comput at ions.
C: Taxation of Limited Companies
C1: COMPUTATION OF CORPORATION TAX
This chapt er will explain how a company calculat es it s cor por at ion t ax liabilit y once PCTCT is known. I n par t icular it will explain how t he level of a company’s pr of it s af f ect s t he r at e of t ax t hat is applied.
C1.1 Rates of tax
Companies pay Cor por at ion Tax f or a chargeable accounting period or CAP. The r ules f or det er mining t he CAPs of a company wer e cover ed in t he f ir st chapt er .
Cor por at ion t ax is calculat ed based on r at es of t ax set by t he Chancellor of t he Exchequer f or each f inancial year . A f inancial year f or companies r uns f r om 1 April t o 31 March and is denot ed by t he year in which it begins. For example, financial year 2006 (FY 2006) runs from 1 April 2006 to 31 March 2007.
The r at es of t ax applicable in t he last f ew f inancial year s ar e as f ollows and ar e given in your t ax t ables:
Financial Year 2006 2002 to 2005 Full r at e 30% 30% Small companies’ r at e 19% 19% St ar t ing r at e N/A 0% Profit limit for starting rate N/A £10,000 Prof it limit f or st ar t ing r at e mar ginal r elief N/ A £ 50,000 Prof it limit f or small companies’ rate £300,000 £300,000 Prof it limit f or small companies’ mar ginal r at e £ 1,500,000 £ 1,500,000
Mar ginal r elief f r act ion - small companies’ r at e 11 11
400 400
Mar ginal r elief f r act ion – st ar t ing r at e N/ A 19
400
Ther e has been a signif icant change in t he cor por at ion t ax r at es wit h ef f ect f r om FY 2006 as t he 0% “st ar t ing r at e” has been abolished. We will r et ur n t o t his lat er . 92 Principles of Business Taxat ion ‘Finance Act 2006’
Companies pay tax on t heir pr of it s char geable t o cor por at ion t ax (PCTCT). However , t he rate of tax is determined by a company’s “notional profit” (NP).
For example, if a company has not ional pr ofit of £ 2m, it will be a “lar ge” company and will pay cor por at ion t ax on t he whole of it s PCTCT at t he f ull rat e of 30%.
A company wit h not ional pr of it of , say, £ 100,000 will be a “small” company and it s PCTCT would be f ully char ged at t he small companies r at e of 19%.
Companies whose not ional pr of it is bet ween t he limit s ar e known as “mar ginal” companies and will r eceive “mar ginal r elief ”. We will look at mar ginal r elief lat er in t his chapt er .
Diagr ammat ically, t he r at es of cor por at ion t ax as t hey apply f or FY 2006 can be shown as f ollows:
30%
£ 1,500,000
“Mar ginal r elief ”
£ 300,000
19%
“Prof it s”
For FY 2002 t o FY 2005 t her e was an addit ional mar ginal calculat ion f or pr of it s bet ween £ 50,000 and £ 10,000.
C1.2 Notional profit
The notional profit is obtained by taking PCTCT and adding to it dividends r eceived, gr ossed up at a r at e of 100/ 90.
This gr oss dividend f igur e is known as franked investment income and is commonly shor t ened t o FII.
Comput at ion of Cor por at ion Tax 93
This gives us t he not ional pr of it and it is t his f igur e which we compar e wit h t he limit s in t he t ax t ables t o det er mine t he r at e of t ax applicable t o t he par t icular company.
PCTCT X 100 FII = Dividends received x X 90
Notional profit X
Remember t hat UK dividends r eceived by a UK company ar e not char ged t o cor por at ion t ax.
We only consider UK dividends received in or der t o det er mine t he rate at which t he company will pay cor por at ion t ax.
Fur t her mor e we only consider UK dividends r eceived f r om non-group companies. We will look at t he def init ion of non-gr oup companies lat er .
Illustration 1
Two separ at e companies, A Lt d and B Lt d make up account s f or t he 12 mont hs t o 31 March 2007. Their PCTCTs f or t he period are:
A Ltd £200,000 B Ltd £2,000,000
Bot h companies r eceive UK dividends of £ 1,800.
To comput e each company’s CT liabilit y f or t he year t he f ollowing met hod should be used:
1) Calculat e t he notional profit f igur e;
2) Consider t he limits t o det er mine which rate is t o be applied t o t he PCTCT;
3) Apply t he CT rate to the PCTCT.
A Ltd B Ltd ££ PCTCT 200,000 2,000,000 FII £1,800 x 100/90 2,000 2,000 “ Notional Profit” 202,000 2,002,000
Rat e t o be applied 19% 30%
£200,000 x 19% £38,000 £ 2m x 30% £ 600,000
94 Principles of Business Taxat ion ‘Finance Act 2006’
Remember t hat t he dividends ar e not t axable income in t he hands of a company, but t hey are included t o decide what rate of t ax will be payable on t he t axable pr of it s (PCTCT).
Example 1
Consider t he f ollowing companies wit h a year end of 31 March 2007:
X Ltd Y Lt d £ £ PCTCT 1,400,000 280,000 Dividends r eceived 100,000 16,200
Calculat e t he cor por at ion t ax liabilit y f or each company.
C1.3 Marginal relief
Mar ginal r elief applies wher e a company’s notional profit is between upper and lower profit limits of £ 300,000 and £ 1.5m. s.13
I n comput ing t he cor por at ion t ax liabilit y, PCTCT is initially taxed at the full rate of 30% wher e pr of it s ar e bet ween t he lower and t he upper limit s.
Marginal relief is then deducted.
Mar ginal r elief is given by t he f or mula:
Fraction x (Upper Limit – Notional Profit) x PCTCT Notional Profit
11 I n FY 2006 t he f ract ion is and t he mar ginal r elief calculat ed is deduct ed 400 f r om t he init ial calculat ion of cor por at ion t ax at 30% t o give t he act ual t ax payable.
Illustration 2
A company has t he f ollowing r esult s f or t he year t o 31 March 2007: £ PCTCT 500,000 FI I 80,000 Not ional Prof it £ 580,000
Comput at ion of Cor por at ion Tax 95
The not ional pr of it is bet ween t he £300,000 and £ 1,500,000 limit s and mar ginal relief will apply. The t ax calculat ion will be: £ £ 500,000 x 30% 150,000 Less: mar ginal r elief 11 500000 x (1,500,000 – 580,000) x 400 580000 (21,810) Gross Cor por at ion Tax (GCT) £128,190
Example 2
G Lt d has f ollowing f or r esult s t he year ended 31 March 2007: £ Schedule DI 250,000 Schedule A 60,000 Capit al gain 180,000 Dividends r eceived 18,000
Calculat e t he Gross Cor por at ion Tax payable.
C1.4 Abolition of the starting rate
Since FY 2002, pr of it s of £ 10,000 or less have been char ged at t he “st ar t ing r at e” of 0%.
For FY 2006 t he starting rate of tax does not apply. Prof it s of £ 10,000 or less ar e now char ged at t he small companies r at e of 19%.
Wher e account ing per iods st r addle 1 Apr il 2006 (e.g. year ended 31 December 2006), par t of t he pr of it s ar e char ged at t he FY 2005 r at es and par t ar e t axed at t he FY 2006 r at es. We t her ef or e need t o time apportion PCTCT and notional profits in or der t o calculat e cor por at ion t ax.
Illustration 3
A company has PCTCT of £ 8,000 and FI I of £ 1,500 f or the year ended 30 Sept ember 2006. This year end st r addles FY 2005 and FY 2006.
96 Principles of Business Taxat ion ‘Finance Act 2006’
Ther ef or e we appor t ion PCTCT, t he limit s and FI I as f ollows:
FY 2005 FY 2006 6/ 12 6/ 12 £ £ PCTCT 4,000 4,000 FI I 750 750 Not ional pr of it s 4,750 4,750
Profit limit for starting rate 5,000 N/A
Rat e of t ax 0% 19%
Gross Cor por at ion Tax £4,000 x 0% / £4,000 x 19% £0 £ 760
Tot al £760
We could have r eached t he same answer by consider ing t he company’s average rate of tax. The company will pay t ax at 0% f or t he f ir st six mont hs and 19% f or t he second six mont hs. The aver age r at e of t ax is:
6/ 12 x 0% 0% 6/12 x 19% 9.5% Aver age r at e 9.5%
I f we apply 9.5 % t o pr of it s we get £ 8,000 x 9.5 % = £ 760
Using t he aver age r at e is quicker .
Example 3
A company wit h a 31 December 2006 year -end has PCTCT of £ 4,000 and dividends r eceived of £ 450.
Calculat e t he Cor por at ion t ax payable.
C1.5 Abolition of starting rate marginal relief
Bef or e FY 2006, mar ginal r elief also applied t o not ional pr of it s bet ween £ 10,000 and £ 50,000. The marginal relief fraction was 19/400. The mar ginal r elief calculat ed was deduct ed f r om t he initial calculat ion of cor por at ion t ax at 19% t o give t he act ual t ax payable. Comput at ion of Cor por at ion Tax 97
30%
£ 1,500,000
“Mar ginal r elief ”
£ 300,000
19%
£ 50,000
“Mar ginal r elief ”
£ 10,000
0%
Profits
Once again wher e a company has an account ing per iod t hat st r addles 1 Apr il 2006, we apportion the profits and see if st ar t ing r at e mar ginal r elief would apply f or t he per iod f alling wit hin FY 2005. This will apply if not ional pr of it s f or t he account ing per iod ar e less than £50,000.
Illustration 4
A company has PCTCT of £ 36,000 and FI I of £ 4,000 in it s year ended 30 J une 2006. This year end st r addles t wo f inancial year s, FY 2005 and FY 2006. The company’s pr of it s and FI I t her ef or e need t o be appor t ioned t o t he t wo per iods:
FY 2005 FY 2006 9/ 12 3/ 12 £ £ PCTCT 27,000 9,000 FI I 3,000 1,000 Notional profit 30,000 10,000
98 Principles of Business Taxat ion ‘Finance Act 2006’
We need t o consider t he st ar t ing r at e as t he f ir st 9 mont hs’ char geable pr of it s f all int o FY 2005. The second 3 mont hs of t he account ing per iod f all wit hin FY 2006. As t he st ar t ing r at e has been abolished t hey will be t axed at 19%.
The st ar t ing r at e limit should be t ime appor t ioned f or t he 9 mont h per iod:
Profit limit for starting rate £10,000 x 9/12 = £7,500 Prof it limit f or st ar t ing r at e mar ginal r elief £ 50,000 x 9/12 = £37,500
The company’s not ional pr of it in FY 2005 is bet ween t hese limit s and t her ef or e st ar t ing r at e mar ginal r elief applies. The t ax is t her ef or e calculat ed as f ollows:
FY 2005 FY 2006 £ £ Cor por at ion t ax: £27,000 x 19% 5,130 £ 9,000 x 19% 1,710 Mar ginal r elief : 19/ 400 x £ (37,500 - 30,000) x 27,000 30,000 (321) N/A £ 4,809 £ 1,710
Tot al £6,519
Comput at ion of Cor por at ion Tax 99
Answer 1
X Ltd Y Lt d £ £ PCTCT 1,400,000 280,000 100 111,111 18,000 FI I (dividends x ) 90 Not ional pr of it £ 1,511,111 £ 298,000
> 1.5m limit < £ 300k limit
Tax r at e 30% 19%
Cor por at ion Tax (PCTCT x r at e)
£ 1,400,000 x 30% £420,000 £280,000 x 19% £53,200
Answer 2
G Ltd £ Schedule DI 250,000 Schedule A 60,000 Capit al gain 180,000 PCTCT 490,000 100 20,000 FI I ( ) 90 £ 510,000
Bet ween limit s
£ Cor por at ion t ax: £490,000 x 30% 147,000
Less mar ginal r elief : 11 490000 (26,157) x (1,500,000 – 510,000) x 400 510000 GCT £120,843
100 Principles of Business Taxat ion ‘Finance Act 2006’
Answer 3
FY 2005 FY 2006 3/ 12 9/ 12 £ £ PCTCT 1,000 3,000 FII (£450 x 100/90 = £500) 125 375 Not ional pr of it 1,125 3,375
The company has not ional pr of it s below £ 2,500 (£ 10,000 x 3/ 12), t hus t he st ar t ing r at e applies f or FY 2005. Prof it s ar e t axed at 19% in f or FY 2006.
Profit limit for starting rate 2,500 N/A
Rat e of t ax 0% 19%
Gross Cor por at ion Tax £1,000 x 0% / £3,000 x 19% £0 £ 570
Tot al £570
Alt er nat ive answer
The aver age r at e of t ax is: % 3/ 12 x 0% 0 9/ 12 x 19% 14.25% Aver age r at e 14.25%
CT: £4,000 x 14.25% £570
Comput at ion of Cor por at ion Tax 101
SUMMARY – COMPUTATION OF CORPORATION TAX
Companies pay t ax based on t he level of t heir not ional pr of it s.
Not ional Prof it s = PCTCT + FI I (UK dividends r eceived x 100/ 90)
“Mar ginal r elief ” applies t o companies whose not ional pr of it s ar e bet ween t he r elevant limit s.
The f or mula f or mar ginal r elief is Fract ion x (Upper Limit – Not ional Prof it ) x PCTCT Not ional Prof it
The upper limit will be eit her £ 1,500,000 or £ 50,000 depending on which limit s t he pr of it s ar e bet ween.
The mar ginal r elief amount is deduct ed f r om t he init ial calculat ion of cor por at ion t ax at eit her t he f ull r at e or t he small companies r at e t o give t he act ual t ax payable.
The 0% “st ar t ing r at e” has been abolished f or FY 2006. Ther ef or e, wher e account ing per iods st r addle 1 Apr il 2006 and not ional pr of it s ar e less t han £ 50,000, we must appor t ion t hese pr of it s bet ween FY 2005 and FY 2006 t o see if t he st ar t ing r at e / st ar t ing r at e mar ginal r elief applies.
C2: ASSOCIATED COMPANIES
This chapt er looks at t he impact of associat ed companies when consider ing what r at e of cor por at ion t ax a company should pay.
C2.1 Definition
Companies ar e associated wit h each ot her if one company controls another company, or two companies ar e controlled by the same person or per sons.
The definition of person in t he Taxes Act is ver y wide. I t includes, f or inst ance, a company, an individual, or individuals, trustees of a t r ust , or partners in a par t ner ship. For inst ance if I CI plc has t wo subsidiar ies, bot h of t hem ‘cont r olled by’ I CI , all 3 companies ar e associat ed.
Control means more than 50% of any of t he f ollowing: s.416 (i) Vot ing power ; or (ii) Or dinar y shar e capit al (not f ixed r at e pr ef er ence shar es); or (iii) Ent it lement t o dist r ibut able pr of it s; or (iv) Ent it lement t o asset s on a winding up.
Example 1
Which of t he f ollowing companies ar e associat ed wit h Mouse Limit ed, a company owned ent ir ely by Mickey? a) Rat Limit ed, a company in which Mickey owns 50% of t he or dinar y shar es. b) Cheese Limit ed, a company wholly owned by Mouse Limit ed. c) Mole Limit ed, a company in which Mickey owns 40% of t he shar es which ent it le him t o 60% of t he dist ribut able prof it s. d) Tr ap Limit ed, a company in which Mouse Limit ed owns 10% of t he shar es but has 55% of t he vot ing power .
C2.2 Implications
The exist ence of associat ed companies means t hat : • When computing FI I (Fr anked I nvest ment I ncome) we ignore any dividends received from associated companies. • The corporation tax limits, t hat is t he £ 1.5 million, £ 300,000, ar e divided equally among all of the associated companies. Remember f or FY 2005 we may need t o divide t he £ 50,000 and £ 10,00 limit s t hat applied. Associat ed Companies 103
Ther ef or e in t he last example, we would ignor e any dividends r eceived by Mouse Lt d f r om Cheese Lt d and Tr ap Lt d in comput ing not ional pr of it f or Mouse Lt d and when we comput e Mouse Lt d’s cor por at ion t ax liabilit y, we would have t o divide t he limit s by f our as t her e ar e f our associat ed companies (Mouse Lt d plus it s t hr ee associat es).
Not e t hat it is t hese r evised limit s t hat ar e used in any mar ginal r elief calculat ion.
Illustration 1
I ain Lt d has t he f ollowing income f or t he year ended 31 March 2007
PCTCT £120,000
Dividends f r om non-associat ed companies £ 18,000
Dividends f r om associat ed companies £ 45,000
We will assume t hat it has:
(a) one associat ed company
(b) t wo associat ed companies
(c) t welve associat ed companies
and will show how t he cor por at ion t ax char ge is calculat ed in each case.
To comput e t he CT liabilit y:
St ep One: Consider t he small company limit s How many associat ed companies ar e t her e? Remember t o include I ain Lt d it self !
(a) (b) (c) £ 300,000 & £ 1,500,000 divided by £ 150,000 (a) 2 & £ 750,000 £ 100,000 (b) 3 & £ 500,000 £ 23,077 (c) 13 & £ 115,385
104 Principles of Business Taxat ion ‘Finance Act 2006’
St ep Two: Calculat e t he “not ional pr of it s” I gnor e dividends f r om associat es
PCTCT 120,000 120,000 120,000
FII £18,000 x 100/90 20,000 20,000 20,000 Not ional pr of it s 140,000 140,000 140,000
St ep Thr ee: Decide which t ax r at e applies:
19% Mar ginal 30% St ep Four : Comput e t he liabilit y:
a) £ 120,000 x 19% £22,800
b) £120,000 x 30% 36,000 Less: 11 x (£ 500,000 – 140,000) x 120,000 ( 8,486) 400 140,000 £27,514
c) £ 120,000 x 30% £36,000
Example 2
Plant Lt d and Flower Lt d each have 2 associat ed companies. Their pr of it s in t he year ended 31 Mar ch 2007 ar e as f ollows:
Plant Ltd Flower Lt d £ £ PCTCT 450,000 120,000 FI I 60,000 30,000
Calculat e t he Gross Cor por at ion Tax liabilit y in each company.
C2.3 Associates s.417
When det er mining whet her companies ar e associat ed, t he holdings of an individual must be added t o holdings of his associat es. These include t he individual and his spouse, plus also his br ot her s and sist er s, childr en and r emot er issue, i.e. gr andchildr en et c.
I ndividuals ar e also associat ed wit h par ent s and r emot er f or bear , i.e. gr andpar ent s et c. and any business par t ner s t r ading in par t ner ship. This does not ext end t o individuals who ar e dir ect or s in t he same company. We also appor t ion t he r ight s and power s of t r ust ees, wher e t he set t lor is t he individual Associat ed Companies 105
or an associat e of t hat individual. The set t lor is t he per son who act ually put s t he money int o t he t r ust .
Example 3
Sam invit es t he f ollowing people r ound t o dinner : a) His brot her b) His br ot her ’s wif e c) His godson d) His ex-wif e e) His business par t ner f) His gr andmot her g) His bank manager .
Who is associat ed wit h Sam?
C2.4 Other rules
Companies ar e associated for a whole accounting period. Ther ef or e we include companies t hat j oin or leave t he gr oup dur ing t he year , even t hough t hey ar e only s.13(5) associat ed f or par t of t he per iod.
We also include all worldwide companies. Alt hough only UK companies ar e subj ect t o cor por at ion t ax, exist ence of wor ldwide subsidiar ies or holding companies will dilut e t he upper and lower limit s.
Dormant companies are excluded. A dor mant company is basically one t hat is not doing anyt hing. I n J owet t v O’Neill v Br ennan Const r uct ion Lt d, a company simply holding f unds in a bank deposit account and r eceiving int er est income, was not an act ive company and count ed as dor mant f or associat ed company pur poses. s.513(3) Prior t o t his decision, t he Revenue believed t hat a company was only dor mant if it had no income. Fr om t his decision, t he company is dormant provided it has no activity.
C2.5 Holding companies
Pur e holding companies will be t r eat ed as dor mant pr ovided t hat all of t he SP5/ 94 f ollowing apply:
• I t has no asset s ot her t han shar es in 51% subsidiar ies. • I t is not ent it led t o any deduct ions f or char ges or management expenses in r espect of any out goings. • I t has no income or gains ot her t han dividends which it has dist ribut ed in f ull t o it s member s.
106 Principles of Business Taxat ion ‘Finance Act 2006’
C2.6 Concession
The Revenue will t r eat t he def init ion of a r elat ive as including only a spouse or minor child so long as t her e is no “subst ant ial commer cial int er dependence” bet ween t he t wo companies. Ther e is no clear def init ion of what is “subst ant ial commer cial int er dependence”. The Revenue will look at all t he f act s. The Revenue ESC C9 have indicat ed t hat it means r eliance on each ot her . This is not necessar ily a f inancial t est and can r elat e t o f act or s t hat cannot be measur ed numer ically such as shar ed dir ect or s or f acilit ies.
C2.7 Sub-subsidiaries
Sub-subsidiar ies, i.e. wher e one company cont r ols anot her , which in t ur n cont r ols anot her , ar e also included as associated companies. The def init ion is a ver y wide one. Ther ef or e if one company cont r ols anot her , and t hat cont r ols anot her , we do not need to multiply the holdings downwards t o wor k out whet her one company owns mor e t han 50% of anot her . I n ot her wor ds, you do not need t o use your calculat or in det er mining whet her companies ar e associat ed.
Example 4
Consider t he f ollowing gr oup st r uct ur e:
Mr A
80% 60%
A Ltd D Lt d
51% 60% 45%
E Lt d B Lt d C Lt d 51% (Dor mant ) (acquir ed dur ing t he AP) F Lt d
How many companies ar e associat ed wit h A Lt d f or it s account ing per iod t o 31 December 2007?
Associat ed Companies 107
Answer 1
(b), (c) and (d)
Not e t hat t he cont r ol condit ion is mor e t han 50% hence in (a) Rat Limit ed is not associat ed wit h Mouse Lt d.
For t he ot her s we t ake t he highest per cent age of vot ing power , shar es, pr of it s or asset s t o det er mine whet her t he cont r ol condit ion is sat isf ied.
Ther ef or e Mouse Lt d has 3 associat ed companies and t her e ar e 4 associat ed companies in t ot al.
Answer 2
Plant Lt d Flower Lt d £ £ PCTCT 450,000 120,000 FII 60,000 30,000 £ 510,000 £ 150,000 Adjusted prof it limits (Each company has 2 associat es) £1,500,000/3 = £500,000 >500k Between limits £ 300,000/ 3 = £ 100,000
Cor por at ion t ax: £ £ £ 450,000 x 30% 135,000
£ 120,000 x 30% 36,000 Less mar ginal r elief : 11 120000 (£ 500,000 – 150,000) x 400 150000 ______(7,700) £135,000 £28,300
108 Principles of Business Taxat ion ‘Finance Act 2006’
Answer 3
(a), (e) and (f) only
Answer 4
A Lt d has 3 associates: D Lt d, E Lt d and F Lt d Associat ed Companies 109
SUMMARY – ASSOCIATED COMPANIES
The pr of it s limit s ar e r educed f or associat ed companies.
Dividends r eceived f r om associat ed companies ar e ignor ed in det er mining FI I .
Associat ed companies ar e companies under common cont r ol (i.e. >50%).
Common cont r ol can be by another company or an individual.
Dor mant companies ar e excluded.
Over seas companies ar e included.
Companies which become associat es or cease t o be associat es dur ing t he account ing per iod count as associat es f or t he whole account ing per iod.
When looking at sub-subsidiar ies t her e is no need t o mult iply t hr ough t o f ind an ef f ect ive int er est – t he sub-subsidiar ies will be associat ed wit h t he t op company in t he gr oup pr ovided t her e is cont r ol (i.e. > 50%) at each level.
C3: SHORT ACCOUNTING PERIODS
This chapt er demonst r at es how t o calculate t he t ax liabilit y of a company t hat has an account ing per iod of less t han 12 mont hs
C3.1 Apportioning the limits
The cor por at ion t ax limit s apply t o a t welve mont h per iod. Ther ef or e, when t he chargeable account ing period is less t han 12 mont hs long, t he limit s must be time apportioned.
Illustration 1
Duncan Ltd changed its year end from 31 March to 31 December. With this in mind, it makes up it s account s f or t he 9 mont hs t o 31 December 2006.
To det er mine t he amount of t ax payable it is necessar y t o know t he small companies limit s. These need t o be adjusted for the fact that there are only 9 month accounts pr epar ed.
The limit s become:
£300,000 x 9/12 £225,000 £ 1.5m x 9/ 12 £ 1,125,000
The limit included in t he mar ginal r elief calculat ion should be t he r evised limit:
Fr act ion x £ (1,125,000 – Not ional pr of it ) x PCTCT Not ional Prof it
Assume t hat Duncan Lt d’s r esult s f or t he 9 mont hs ended 31 December 2006 ar e as f ollows: £ PCTCT 200,000 FI I 50,000 Not ional pr of it s 250,000
As not ional pr of it s ar e bet ween t he limit s, mar ginal r elief applies:
GCT: £ £200,000 x 30% 60,000 Less mar ginal r elief 11 200000 x (1,125,000 – 250,000) x 400 250000 (19,250) Gross cor por at ion t ax £ 40,750 Short Account ing Periods 111
Example 1
What will t he limit s be f or an 8 mont h char geable account ing per iod? Upper Limit Lower Limit
Example 2
Geor ge Limit ed and Zippy Limit ed make up account s f or t he 8 mont hs ended 30 November 2006 which show t he f ollowing r esult s:
Geor ge Lt d Zippy Lt d £ £ PCTCT 1,300,000 198,000 Dividends received 45,000 7,200
Calculat e t he gr oss cor por at ion t ax f or each company.
C3.2 Short APs and associates
I f a company had a shor t account ing per iod t oget her wit h associat ed companies, t he met hodology r emains t he same i.e. ascer t ain t he amended limit s and calculat e t he t ax accor dingly.
Illustration 2
Ashdown Lt d has 3 subsidiar ies. I t dr aws account s f or a 6 mont h per iod ended 30 Sept ember 2006.
The limit s become:
6 1 £ 300,000 x x 12 4 £ 37,500 6 1 £ 1,500,000 x x 12 4 £ 187,500
The r esult s f or t he 6 mont hs ended 30 Sept ember 2006 are:
PCTCT 160,000 FI I 30,000 Not ional pr of it s 190,000
As not ional pr of it s exceed t he upper limit , Ashdown Lt d is t r eat ed as a “Lar ge” company and will pay cor por at ion t ax at t he f ull rat e: i.e.
£ 160,000 x 30% = £ 48,000
112 Principles of Business Taxat ion ‘Finance Act 2006’
Example 3
Par asol Lt d dr aws up account s f or t he period 1 April 2006 t o 30 November 2006, showing PCTCT of £ 22,000 and FI I of £ 12,000. Par asol Lt d has one associat ed company.
Calculat e t he gr oss cor por at ion t ax liabilit y.
Example 4
Ar cher Limit ed dr aws up account s f or t he period 1 January 2006 t o 30 Sept ember 2006 showing PCTCT of £ 56,000 and dividends r eceived f r om non- associat ed companies of £ 4,000. Ar cher Limit ed has f our associat ed companies.
You ar e r equir ed t o calculat e t he gr oss cor por at ion t ax liabilit y.
Short Account ing Periods 113
Answer 1
8 £1,000,000 Upper limit (£ 1,500,000 x ) 12 8 £200,000 Lower limit (£ 300,000 x ) 12
Answer 2
Geor ge Lt d Zippy Lt d £ £ PCTCT 1,300,000 198,000 100 50,000 8,000 FI I (dividends x ) 90 Not ional pr of it £ 1,350,000 £ 206,000
Relevant limit s: UL 1,000,000 1,000,000 LL 200,000 200,000 Over upper limit Bet ween limit s
Cor por at ion Tax: £ £ £1,300,000 x 30% 390,000 £ 198,000 x 30% 59,400
Marginal relief: 11 (20,987) (1,000,000 – 206,000) x 400 198,000/ 206,000 ______£390,000 £38,413
114 Principles of Business Taxat ion ‘Finance Act 2006’
Answer 3
£ PCTCT 22,000 FI I 12,000 £ 34,000
Prof it Limit s (2 associat es and an 8 mont h CAP) 1500000 8 500,000 x 2 12 300000 8 100,000 x 2 12
Small companies r at e applies: £ 22,000 x 19% £4,180
Answer 4
£ PCTCT 56,000 100 4,444 FI I (dividends x ) 90 Not ional Prof it £ 60,444
Prof it Limit s (5 associat es and a 9 mont h CAP) 1500000 9 225,000 Upper limit : x 5 12 300000 9 45,000 Lower limit : x 5 12 Bet ween limit s so mar ginal relief
Cor por at ion t ax £ £ 56,000 x 30% 16,800 Less: Mar ginal r elief 11 56000 x (225,000 – 60,444) x 400 60444 (4,192) GCT £12,608
Not e: Alt hough t he account ing per iod st raddled 1 April 2006 no addit ional calculat ions wer e r equir ed - st ar t ing r at e mar ginal r elief was not in point as t he company has 4 associat es.
Short Account ing Periods 115
SUMMARY – SHORT ACCOUNTING PERIODS
Wher e a company makes up it s account s f or less t han 12 mont hs, it is necessar y t o adj ust t he cor por at ion t ax limit s on a pr o-r at a basis.
Limit s x n 12
wher e n = number of mont hs in t he shor t account ing per iod.
These adj ust ed limit s ar e also used in t he mar ginal r elief calculat ions.
C4: LONG PERIODS OF ACCOUNT
This chapt er demonst r at es how t o calculat e t he t ax liabilit y of a company t hat dr aws up account s f or a per iod mor e t han 12 mont hs long.
C4.1 Introduction
A char geable account ing per iod (CAP) f or cor por at ion t ax cannot exceed 12 months. However , under company law, account s can be dr awn up f or per iods as s.12 long as 18 months. The period f or which accounts are made up is known as the per iod of account (POA).
Wher e a per iod of account exceeds 12 months, it must be split into two separ at e CAPs f or t ax pur poses. The f irst will be t he first 12 months, because a CAP cannot exceed 12 mont hs. The second will be the balance of the period, because a CAP always ends when a per iod of account ends.
Example 1
Longt on Limit ed makes up a set of account s f or t he 16 mont hs ended 31 J uly 2006.
What ar e t he char geable account ing per iods her e?
C4.2 Splitting the profits
Once we have wor ked out t he account ing per iods, we then split the company’s income between the two separate CAPs, as the accounts will have been drawn up showing pr of it s f or t he ent ir e per iod of account .
Tr ading pr of it is adj ust ed f or t he ent ir e per iod f or disallowed it ems, such as ent er t aining and depr eciat ion. The adj ust ed r esult is t hen t ime appor t ioned t o t he t wo per iods.
As f ar as capital allowances ar e concer ned, we have t o pr epar e separate computations f or each CAP t aking account of addit ions and disposals in each separ at e CAP. We claim a separ at e wr it ing down allowance f or each of t he t wo CAPs, r emember ing t hat t he writing down allowance is time apportioned f or the second CAP. First year allowances however do not need to be time apportioned.
Long Periods of Account 117
Illustration 1
Longt on Limit ed pr epar es account s f or t he 16 mont hs ended 31 J uly 2006. The adj ust ed pr of it bef or e capit al allowances f or t he per iod is £ 480,000.
You ar e also given t he f ollowing inf or mat ion in r espect of capit al allowances:
Plant pool b/f 1.4.05 £30,000 Additions: 1.1.06 £8,000 1.6.06 £6,000 Disposals: 1.7.06 £ (3,000)
Longt on Limit ed is a medium sized company and is eligible f or 40% f irst year allowances.
The Schedule DI prof it f or each CAP is as f ollows: 12m t o 31.3.06 4m t o 31.7.06 £ £ Adj ust ed pr of it bef or e capit al allowances 12 4 360,000 120,000 £ 480,000 x , 16 16 Less capit al allowances (below) (10,700) (4,425) Schedule D Case I pr of it s £ 349,300 £ 115,575
FYAs Gener al Pool Claim Y/ e 31.3.06: Pool at 1.4.05 30,000 Addit ion: Machine (1.1.06) 8,000 FYA @ 40% (3,200) 3,200 WDA @ 25% _____ (7,500) 7,500 4,800 22,500 £ 10,700 Tr ansf er t o pool 4,800 TWDV c/ f 27,300
4 m/ e 31.7.06 Addit ion: Machine (1.6.06) 6,000 FYA @ 40% (2,400) 2,400 Disposal: Machine (1.7.06) _____ (3,000) 3,600 24,300 4 WDA @ 25% x 12 (2,025) 2,025 22,275 £ 4,425 Tr ansf er t o pool 3,600 TWDV c/ f 25,875
Not e how WDAs have been appor t ioned in t he second CAP but FYAs have not .
118 Principles of Business Taxat ion ‘Finance Act 2006’
C4.3 Splitting other income and charges
Schedules A, DIII, and DVI ar e split on a time apportionment basis as t he accr uals basis of account ing applies t o t hese sour ces of income.
Management expenses f or an invest ment company ar e split on an accr uals basis.
Chargeable gains ar e split bet ween t he t wo separ at e account ing per iods based on t he date of disposal of t he asset . This is t he dat e of a binding cont r act of sale, which f or pr oper t y is t he dat e of exchange of cont r act s.
Charges on income, ar e split bet ween t he per iods based on t he date that the amount was act ually paid.
Franked investment income, is split bet ween t he account ing periods based on the date of receipt of t he dividend.
We must be car ef ul wit h t he t ime appor t ionment of Schedule A, DI I I or DVI income wher e t he sour ce is acquir ed par t way t hr ough t he account ing per iod. I n t his case, we must t ime appor t ion t he income over t he per iod in which it ar ose, r at her t han f or t he ent ir e account ing per iod.
Af t er all t he income and char ges have been allocat ed t o t he r elevant CAP, t wo separ at e CT comput at ions ar e pr epar ed f or t he t wo separ at e per iods.
As we shall see lat er , t hese t wo separ at e CT liabilit ies are paid at dif f erent t imes so t her e is never any point in adding t hem t oget her .
I t is also possible f or a company t o pay t ax at dif f er ent r at es f or t he t wo per iods.
For example, a company could pay t ax at t he small companies r at e in t he f ir st (12 mont h) CAP, but t hen pay t ax at t he f ull rat e in t he ot her (short ) CAP if , f or example, a lar ge capit al gain f ell int o t his lat t er per iod.
Illustration 2
Longt on Limit ed (f r om I llust r at ion 1) also r eceived and paid t he f ollowing:
I nt er est income (bank account opened in 1991) £ 8,000 Schedule A r ent s (pr oper t y acquir ed 1.1.06) £ 14,000 Capit al gains (asset sold 30.5.06) £10,000 Annual gif t aid donat ion (paid 1 J uly each year ) £ 1,000 pa
Long Periods of Account 119
We split t hese amount s bet ween t he char geable account ing per iods f or t he 16 mont hs t o 31 J uly 2006 as f ollows: 12m t o 31.3.06 4m t o 31.7.06 £ £ 12 4 6,000 2,000 Schedule DI I I ( , ) 16 16 Schedule A 3 6,000 1.1.06 – 31.3.06 ( ) 7 4 8,000 1.4.06 – 31.7.06 ( ) 7 Char geable gain 10,000 Char ge on income (paid basis) (1,000) (1,000)
Not e. The Schedule A sour ce commenced on 1.1.2006. The rent s of £ 14,000 t heref ore ar ise over a 7 mont h per iod. Thr ee mont hs of r ent s ar e accr ued in t he f ir st CAP and f our mont hs ar e accr ued in t he second CAP.
Example 2
I f we also assume t hat Longt on Limit ed r eceived FI I of £ 10,000 on 1 J anuar y 2006, t he cor por at ion t ax comput at ions f or t he 2 per iods can now be shown as f ollows:
Longt on Limit ed 12m t o 31.3.06 4m t o 31.7.06 £ £ Schedule DI 349,300 115,575 Schedule A 6,000 8,000 Schedule DIII 6,000 2,000 Char geable gain - 10,000 Char ges on income (1,000) (1,000) PCTCT 360,300 134,575 FII 10,000 - Notional profit 370,300 134,575
Assuming Longt on Limit ed had one wholly owned subsidiar y which was sold on 1 J anuar y 2006 calculat e t he gr oss cor por at ion t ax liabilit y f or each chargeable account ing per iod.
120 Principles of Business Taxat ion ‘Finance Act 2006’
Example 3
Smit h Lt d makes up it s account s f or t he 18 mont hs t o 30 J une 2006. I t owns 60% of t he shar es of Hague Lt d.
I t has t he f ollowing income and expendit ur e:
Adjusted profit before CAs £240,000
Rent al income £ 12,000 pa, incr easing t o £15,000 pa from 1 January 2006 £19,500
Bank int er est (accr uing evenly) £3,600
Gain on disposal 14 May 2006 £ 110,000
Dividend received 14 September 2005 £9,000
Gif t Aid donat ions: 1 May 2005 £20,000 1 May 2006 £24,000
The TWDV of t he capit al allowances pool was £ 80,000 on 1 J anuar y 2005. Dur ing t he year t hey had t he f ollowing t r ansact ions:
1 May 2005 Bought P&M £20,000
1 J uly 2005 Bought new car £ 16,000 (MD pr ivat e use 20%)
1 February 2006 Sold P&M £8,000 proceeds
1 March 2006 Bought P&M £12,000
Smit h Lt d is a medium sized company
You ar e r equir ed t o calculat e t he cor porat ion t ax liabilit y f or each chargeable account ing per iod.
Long Periods of Account 121
Answer 1
CAP 1: 1.4.05 to 31.3.06 CAP 2: 1.4.06 to 31.7.06
The per iod of account begins on 1 Apr il 2005 and so t her ef or e, t he f ir st CAP will run t hrough t o 31 March 2006.
The second char geable account ing per iod will st ar t immediat ely af t er war ds on 1 April 2006 and will run t hrough t o t he end of t he per iod of account on 31 J uly. 2006.
Answer 2 12m t o 31.3.06 4m t o 31.7.06 £ £ PCTCT 360,300 134,575 FII 10,000 ______Not ional Prof it 370,300 134,575
Prof it Limit s: 12m t o 31.3.06 - one associat e 1500000
2 £ 750,000 300000
2 £ 150,000 4m t o 31.7.06 – no associat es
4 1,500,000 x 12 £ 500,000 4 300,000 x 12 £ 100,000
Cor por at ion Tax: £ £ £ 360,300 x 30% 108,090 £ 134,575 x 30% 40,373
Mar ginal Relief :
11 360300 (10,160) x (750,000 – 370,300) x 400 370300
11 (10,049) x (500,000 – 134,575) 400
GCT £97,930 £30,324
122 Principles of Business Taxat ion ‘Finance Act 2006’
Answer 3
Comput at ion of cor por at ion t ax liabilit y:
12 mont hs t o 6 mont hs t o 31.12.05 30.6.06 £ £ Adjust ed prof it (12:6) 160,000 80,000
CAs (W1) ( 31,000) (14,300) Schedule DI 129,000 65,700
Schedule A 12,000 7,500
DI I I (12:6) 2,400 1,200
Gain 110,000 ______143,400 184,400
Less: char ges ( 20,000) (24,000)
PCTCT 123,400 160,400
CT (W2) £ 123,400 x 19% 23,446
£ 160,400 x 30% 48,120
11 Less: x (375,000 – 160,400) 400 (5,902) 42,218
Long Periods of Account 123
(W1) CAs
FYA Gener al Pool Car > £ 12,000 Tot al £ allowances £ £ 12 m t o 31 December 2005 TWDV b/ f 80,000 Addit ion – car (no FYAs) 16,000
WDA 25% (20,000) 20,000 Maximum £ 3,000 ( 3,000) 3,000 60,000 13,000 FYA pur chases 1.5.2005 20,000 FYA 40% (8,000) 8,000 12,000 ______31,000 TWDV c/f 72,000 13,000
6m t o 30 June 2006 Disposal (8,000) 64,000 WDA 6/ 12 x 25% (8,000) 8,000 Maximum £ 3,000 x 6/ 12 _____ (1,500) 1,500 56,000 11,500 FYA pur chases 1.3.2006 12,000 FYA 40% ( 4,800) 4,800 7,200 ____ 14,300 TWDV c/f 63,200 11,500
(W2) Tax rat es £ £ PCTCT 123,400 160,400
FII £9,000 x 100/90 10,000 ______Prof it s 133,400 160,400
Limit s – one associat e 150,000/ 750,000
Limit s - 6 mont h account ing per iod 75,000/ 375,000
Tax rat e: 19% Mar ginal relief
124 Principles of Business Taxat ion ‘Finance Act 2006’
SUMMARY – LONG PERIODS OF ACCOUNT
For a company wit h a per iod of account t hat exceeds 12 mont hs, t he per iod of account must be split int o t wo char geable account ing per iods (CAPs) – t he f ir st CAP will be t he f ir st 12 mont hs and t he second CAP will be t he balance (n mont hs).
A separ at e t ax comput at ion must be per f or med f or each CAP.
The adj ust ment of pr of it s, bef or e capit al allowances, is done f or t he per iod of account as a whole.
The income and gains ar e t hen split bet ween t he t wo CAPs as f ollows:
Adj ust ed pr of it Time appor t ionment
Capit al allowances Two comput at ions r equir ed – one f or each CAP Scale down WDA by n/ 12 in shor t CAP but not FYA
Sch A, DI I I and DVI Accruals basis
Gains When r ealised
Char ges When paid
Dividends r eceived When r eceived
Don’t f or get t o t ime appor t ion t he limit s by n/12 when calculat ing cor por at ion t ax f or t he second CAP which will be less t han 12 mont hs long.
C5: CORPORATION TAX SELF ASSESSMENT (CTSA)
This chapt er examines t he Cor por at ion Tax Self Assessment (CTSA) pr ocedur es, including: - f iling r equir ement s; - enquir ies; - claims; - r ecor d keeping.
C5.1 Introduction
Cor por at ion t ax self assessment applies t o all char geable account ing per iods ending on or af t er 1 J uly 1999. The r egime deals wit h all of t he administ r at ion ar eas of cor por at ion t ax which includes t he payment of t ax.
Corporation tax f or smaller companies is due 9 months and 1 day after the end of the chargeable accounting period. Lar ger companies ar e r equir ed t o pay t ax under t he quar t er ly inst alment syst em.
The r egime also deals wit h t he f iling of tax returns (CT600) which give det ails of t he income a company has ear ned, t oget her wit h t he calculat ion of t he corporat ion t ax liabilit y.
The submission of t he t ax calculat ion is compulsor y f or companies, unlike individuals who can shif t t he r esponsibilit y f or calculat ing t he t ax t o t he I nland Revenue pr ovided t hey f ile t he r et ur n by an earlier date. This facility is not available t o companies.
Ther e is a statutory liability for a company to notify chargeability to s.55 FA 2004 corporation tax.
Wher e a company has not r eceived a not ice t o f ile a t ax ret urn (CT603) it must Par a 2(1) give not ice t o t he Revenue wit hin 12 mont hs of t he end of t he account ing per iod Sch 18 FA 1998 t hat it is chargeable t o t ax.
When a company submit s it s form CT600, it will also send in a set of accounts t oget her wit h any ot her det ailed analysis and comput at ions necessar y t o show t hat t he r et ur n is complet e and cor r ect and answer s all of t he Revenue Of f icer ’s most obvious quest ions.
Nor mally a CT600 is due f or submission t o t he Revenue 12 mont hs f r om t he end of t he char geable account ing per iod. For example if t he char geable account ing per iod ends 31 December 2006, t he CT600 must be f iled by 31 December 2007.
126 Principles of Business Taxat ion ‘Finance Act 2006’
However , a lat er f iling dat e may be appropr iat e as a company will always have a minimum of 3 mont hs f r om t he r eceipt of t he f iling not ice. I f t his dat e is lat er t han t he 12 mont h dat e, t hen t his dat e becomes t he new f iling dat e.
Illustration 1
A company makes it s account s f or t he 12 mont hs t o 30 J une 2007. I t r eceives it s CT 600 f or t his period on 30 April 2008.
The nor mal f iling dat e would be 30 J une 2007 + 12m = 30 J une 2008.
Not ice received 30 April 2008 and 3 mont hs af t er t hat is 31 July 2008.
The f iling dat e is t heref ore 31 July 2008 as t his is lat er t han t he nor mal f iling dat e.
C5.2 Long periods of account
Wher e t he company makes up it s account s f or mor e t han 12 mont hs, it is r equir ed t o split it int o t wo account ing per iods f or t he pur poses of calculat ing t he t ax payable. However , f or f iling pur poses, t her e is a single f iling dat e t hat will be 12 mont hs f r om t he end of t he per iod of account .
Two r et ur ns will be submit t ed – one f or each CAP – but t he due dat e f or f iling t hese r et ur ns is t he same.
Illustration 2
A small company dr aws account s f or a 15 mont h per iod ending on 31 Mar ch 2007.
The per iod of account must be divided int o t wo char geable account ing per iods f or t he pur poses of calculat ing cor por at ion t ax:
CAP No. 1: 12 m/ e 31 December 2006 CAP No. 2: 3 m/e 31 March 2007
The due dat es f or t he payment of cor por at ion t ax and f or t he f iling of t he f or m CT600 are: CAP No. 1 CAP No. 2 y/ e 31.12.06 y/ e 31.3.07
Tax due 1.10.07 1.1.08 CT600 due 31.3.08 31.3.08
Two f or ms CT600 will be submit t ed on 31 March 2008, t oget her wit h f inancial st at ement s and cor por at ion t ax comput at ions cover ing bot h char geable account ing per iods. Cor por at ion Tax Self Assessment (CTSA) 127
Example 1
Complet e t he f iling dat e in t he f ollowing:
CAP ends Not ice issued Filing dat e a) 31.3.07 12.11.07 b) 31.5.07 24.3.08
C5.3 Duty to notify chargeability s.55 FA 2004
Companies have an obligation to notify t he Revenue when t heir f ir st account ing period begins or when they come back within the charge to tax. They will also have t o pr ovide cer t ain pr escr ibed inf or mat ion.
The company must give written notice within three months of the start of the s.55(2) FA 2004 accounting period. The notice must state when the accounting period began.
The det ailed inf or mat ion t o be given in t he not ice is as f ollows: SI (a) The company’s name and r egist r at ion number ; 2004/ 2502 Reg 2 (b) The addr ess of t he company’s r egist er ed of f ice; (c) The addr ess of t he company’s pr incipal place of business; (d) The nat ur e of t he business being car r ied on by t he company; (e) The dat e t o which t he company int ends t o pr epar e account s; and (f ) The f ull names and addr esses of t he dir ect or s of t he company. (g) I n t he case of a business f or mer ly car r ied on by ot hers: t he name and addr ess of t hat f or mer business; and t he name and addr ess of t he per son f r om whom t he business was acquir ed. (h) I n t he case of a company which is in a gr oup r elief gr oup: t he name of t he par ent company and t he addr ess of it s r egist er ed of f ice. (i) In the case of a company which, has been obliged to comply with the r equir ement s of t he I ncome Tax (Pay as You Ear n) Regulat ions 2003: t he dat e on which t hat obligat ion f ir st ar ose.
The r ules do not apply to unincorporated associations or partnerships. s.55(5) FA 2004
No failure t o give not ice will ar ise wher e t he company has a reasonable excuse, s.55(4) so long as it gives not ice wit hin a r easonable t ime once t he excuse has passed. FA 2004
128 Principles of Business Taxat ion ‘Finance Act 2006’
C5.4 Para 3 Schedule 18 Notice (CT603)
The Revenue will issue a not ice t o t he company r equir ing it t o f ile a cor por at ion t ax r et ur n. Unt il t his not ice is issued, t he company does not have any obligat ion t o f ile a r et ur n.
The not ice will st at e t he period t o which it r elat es. Par a 5 r ef er s t o t his as t he Par a 5 Sch 18 “specif ied per iod”. FA 1998
(i) I f an account ing per iod ended dur ing (or at t he end) of t he specif ied per iod, a r et ur n is r equir ed f or t hat account ing per iod. I f t her e is mor e t han one such account ing per iod, separ at e r et ur ns ar e made f or each.
(ii) I f (i) above does not apply but an account ing per iod began dur ing t he specif ied per iod, a r et ur n is r equir ed f or that part of the specif ied per iod bef or e t he account ing per iod began.
(iii) I f t he company was out side t he char ge t o t ax f or t he whole of t he specif ied per iod, a t ax r et ur n is r equir ed f or t he whole per iod.
I f none of t he above apply no t ax r et ur n is r equir ed f or t he specif ied per iod.
C5.5 The self assessment
The r et ur n must include a self assessment of t he amount of t ax payable in Par a 7 r espect of t hat per iod based on t he inf or mat ion cont ained in t he r et ur n. Sch 18 FA 1998
The t ax due is calculat ed as f ollows: Par a 8 Sch 18 FA 1998 (i) Take t he PCTCT of t he company and apply t he r at e of t ax applicable t o t he company.
(ii) Then give ef f ect t o any r elief s against cor por at ion t ax: • Mar ginal r elief • CVS r elief • DTR • ACT
(iii) Add any amount s char geable or assessable as if t hey wer e cor por at ion tax: • s.419 penalt y t ax • s.747(4)(a) appor t ionment in r elat ion t o a CFC
(iv) Deduct amount s t o be set against t he over all t ax bill: • I ncome Tax
Cor por at ion Tax Self Assessment (CTSA) 129
Not e: Under CTSA it is t he company’s r esponsibilit y t o ensur e t hat s.419 and s.747(4)(a) t ax is included in t he t ot al amount of t ax payable. Previously separ at e assessment s wer e r aised by t he Revenue in r espect of t hese t axes. Similar ly it is t he company’s r esponsibilit y t o ensur e t hat all necessar y t r ansf er pr icing adj ust ment s ar e made in ar r iving at PCTCT.
C5.6 Processing of the returns
A f or m CT600 is submit t ed t o t he Revenue, and is pr ocessed by t he cor por at ion Par a 16 t ax pr ocessing depar t ment . As par t of t he pr ocessing pr ocedur e t he Revenue will Sch 18 FA 1998 have 9 mont hs f r om t he act ual dat e of f iling t he r et ur n t o cor r ect any obvious er r or s in it . This would include, f or inst ance, wher e a list of f igur es had been added incor r ect ly or t he wr ong r at e of t ax has been t aken.
These er r or s will be ident if ied when t he Revenue t ype t he f igur es f r om t he r et ur n int o t heir comput er syst em, and f ind t hat t her e ar e dif f er ences bet ween t he t wo. I n t his case, t he pr ocessor will wr it e t o t he company and ask f or t he appr opr iat e amendment s t o be made.
The company has 12 months from the due filing date, (not t he act ual f iling Par a 15 Sch 18 dat e) to make any amendments to the return. This could be, f or inst ance, FA 1998 r evising a loss r elief claim, amending a capit al allowances claim, or any ot her amendment s.
Once t he r et ur n has been pr ocessed, it may t hen go t o a Revenue Of f icer , who Par a 24 might give it a mor e det ailed r eview. I f t he Of f icer looks at t he ret urn and t he Sch 18 FA 1998 accompanying account s, and he sees t her e is inf or mat ion t hat he would like t o ask quest ions about , he has 12 months from the due filing date to start an enquiry. I t is ver y impor t ant t hat t he Revenue st ick t o t hese enquir y deadlines, because once t hey have passed t his deadline t her e is very lit t le t hey can do if t hey disagr ee wit h somet hing on t he r et ur n.
I f t he char geable account ing per iod ends on 31 December 2006, t he CT600 must be f iled by 31 December 2007 and any enquir y must commence by 31 December 2008.
For an enquir y t o commence, t he company must r eceive t he not ice of enquir y. The commencement dat e is not t he dat e st at ed on t he enquir y not ice but t he dat e t hat t he company must r easonably be expect ed t o r eceive it . Ther ef or e allowing f or f ir st class post , t his could t ake 3 days or second class post 6 days, so t he Revenue t r y t o make sur e t hey post it well bef or e t he deadline.
I f , however , t he return is filed late, t he Revenue will have a minimum of 12 months to start their enquiries and t he enquir y deadline will move t o t he end of t he next quar t er day. This also applies t o any amendment s r elat ing t o t hat r et ur n which ar e f iled af t er t he nor mal f iling dat e. The Revenue will have ext r a t ime t o st ar t an enquir y in r espect of t hose amendment s only.
130 Principles of Business Taxat ion ‘Finance Act 2006’
The quar t er days do not coincide wit h t he usual quar t er days of t he year . They ar e 31 J anuar y, 30 Apr il, 31 J uly and 31 Oct ober . These ar e t he same quar t er days which apply t o income t ax self assessment .
Illustration 3
Lazy Lt d dr ew account s f or t he 12 mont hs ending 31 May 2006. A not ice t o deliver a r et ur n was r eceived by t he company on 15 J uly 2005, but t he company’s CT600 is not submit t ed t o t he Tax Of f ice unt il 14 August 2007.
The r et ur n should have been f iled by 31 May 2007 – t her ef or e it is lat e.
This ext ends t he deadline by which t he Of f icer can commence an enquir y int o t he r et ur n. The deadline f or commencing an enquir y is t he end of t he calendar quar t er f ollowing t he anniver sar y of t he r et ur n, i.e.
14 August 2007 + 12 mont hs = 14 August 2008 14 August 2008 is in t he q/ e 31 Oct ober 2008
The Of f icer has unt il 31 Oct ober 2008 t o st art an enquir y int o t he r et ur n.
Example 2
Consider t he f ollowing:
(a) (b) CAP ends 31.3.07 31.5.06 CT600 filed 31.1.08 30.6.07
What ar e t he dat es by which t he Revenue may cor r ect obvious er r or s and t he dat es by which t he Revenue may open an enquir y?
C5.7 Enquiries
CTSA enquir ies t ake place t o ensur e t hat companies submit cor por at ion t ax r et ur ns which ar e bot h complet e and cor r ect . An enquir y can st ar t f or a number of r easons. The enquir y could be “random” - gener at ed by t he Revenue’s comput er . The r et ur n could be subj ect t o a “selected” enquir y wher e t he Of f icer has ident if ied somet hing on t he r et ur n which he is not happy about , or wishes t o ask f ur t her quest ions about .
Ther e could also be “routine” enquir ies. This will apply part icularly t o very large companies, wher e simply because of t he amount of pr of it s and t ax involved, t he r et ur n will be subj ect t o an enquir y vir t ually ever y year .
Cor por at ion Tax Self Assessment (CTSA) 131
Select ed and r out ine enquir ies can be avoided by t he company making complet e and t hor ough disclosur e on t he r et ur n of ever yt hing t he Revenue may want t o ask about . I n par t icular , f ull analysis should be given of all cont ent ious expendit ur e headings, such as legal and pr of essional f ees, r epair s expendit ur e and ent er t aining (split bet ween allowable st af f ent er t aining and ot her disallowed ent er t aining). I f t his inf or mat ion is not supplied on t he r et ur n, t he Revenue will have t o st ar t an enquir y t o f ind t he br eak down of t he f igur es.
It is also a good idea to perform an analyt ical r eview of t he pr of it and loss account , as t hough you wer e a Revenue Of f icer . The r et ur n and suppor t ing schedules should at t empt t o explain dif f er ences of income and expendit ur e heads f r om one year t o t he next . I f t her e is a legit imat e r eason f or an incr ease in adver t ising expendit ur e why not explain it , r at her t han t he Of f icer r aising an enquir y?
C5.8 Determinations Par a 36 Sch 18 FA 1998 Det er minat ions ar e issued by t he I nland Revenue wher e a company f ails t o f ile a CT600. This allows t he Revenue t o t ake pr oceedings against t he company t o obt ain t he cor por at ion t ax demanded on t he det er minat ion.
The det er minat ion is t r eat ed like a self assessment , but t he company cannot appeal against it . I t can only be super seded by an act ual self assessment . Ther ef or e, if t he det er minat ion is on t he high side, t he company should submit it s pr oper cor por at ion t ax comput at ions and CT600 as soon as it possibly can, in or der t o halt t he Revenue f r om t aking pr oceedings f or t he ent ir e amount of t ax demanded.
C5.9 Discovery assessments Par a 41 Sch 18 FA 1998 Legislat ion exist s f or dealing wit h “discover y” assessment s f or companies. “Discover y” assessment s can be made wher e t ax has been lost due t o t he fraudulent or negligent conduct of a company, or wher e t he Revenue has not been pr ovided wit h sufficient information to enable them to make a correct assessment of t he company’s pr of it s.
The legislat ion cont ains guidelines on what is considered to be “providing Par a 44 inf or mat ion”. I nf or mat ion is “pr ovided” t o t he Revenue if it is cont ained in eit her Sch 18 FA 1998 t he r et ur n, t he account s or document s suppor t ing or accompanying t he r et ur n or account s, or in claims made by t he company.
For inst ance, assume a company owns a pr oper t y in Por t ugal and f ails t o disclose t he r ent al income on t he r et ur n. I f t he Revenue subsequent ly discover t his, t hey will be able t o r aise an addit ional assessment t o collect t he t ax. The t ax on t he discover y assessment is due on t he nor mal due dat es f or cor por at ion t ax and int er est r uns on any amount s paid lat e.
132 Principles of Business Taxat ion ‘Finance Act 2006’
No “discover y” assessment will be made t o collect f urt her t ax due if an error or Par a 45 mist ake is made wit hin t he r et ur n, but t he or iginal r et ur n was agr eed by t he Sch 18 Of f icer based on t he “prevailing practice” at t he t ime t he f igur es wer e agr eed. FA 1998
C5.10 Error or mistake relief Par a 51 Sch 18 FA 1998 A company can claim er r or or mist ake r elief , if t hey believe t hey have over -paid cor por at ion t ax due t o an er r or or mist ake in a pr evious r et ur n. However , no r elief is available if t he r et ur n is made in accor dance wit h pr act ice t hen pr evailing.
For inst ance a r ecent change in an account ing st andar d might change t he t ax t r eat ment of a par t icular it em. I f under a pr evious st andar d t he it em was t r eat ed dif f er ent ly in t he pr evious t ax comput at ion, t hen no er r or or mist ake claim can be made, as t he pr evious r et ur n was made in accor dance wit h pr act ice pr evailing at t hat t ime.
Changes in case law can also br ing t o light an er r or or mist ake claim. The Revenue will of t en give t heir opinion as t o whet her an er r or or mist ake claim will be accept ed in a par t icular leading case.
I n t he case of Herbert Smith, a f irm of solicit ors successf ully ar gued t hat t he pr ovision f or sublet t ing losses on t heir pr emises wer e allowable in t he year t hat t hey signed t he leases. The Revenue have accept ed t hat an er r or or mist ake claim can be made in r espect of pr evious cases as t hey did not believe t her e was a pr ecedent set in t he past wit h r egar ds t o sublet t ing losses.
However , in t he case of Jenners, t he depar t ment st or e successf ully ar gued t hat t heir r epair s pr ovision, as r equir ed under t he t er ms of t heir lease, should be allowed f or t ax pur poses and was not prevent ed because s 74(1)(d) r equir ed t he money t o be expended. However , t he Revenue’s view is t hat a mist ake claim will not be allowed in r espect of t he J enner s case, as t hey believe t hat pr act ice pr evailing in t he past was t hat gener al r epair s pr ovisions should be disallowed, and t his was widely document ed in many t ax and account ing t ext books.
C5.11 Claims
Claims must be made on the tax return. Examples of claims include losses, gr oup Par a 54 r elief and capit al allowances. The claims t hemselves must be made on t he CT600 Sch 18 FA 1998 and must be quant if ied in amount . Claims may be amended in t he nor mal t ime limit , which is 12 mont hs f ollowing t he nor mal f iling dat e.
The general time limit for claims is six years unless otherwise specified in t he Taxes Act . Supplement ar y claims can be made in t he case of er r or s in claims.
Cor por at ion Tax Self Assessment (CTSA) 133
The Revenue, on issuing an amended self assessment or a discover y assessment can incr ease t he t ime limit f or making or wit hdr awing claims. The t ime limit will be ext ended t o one year af t er t he end of t he account ing per iod in which t he assessment is issued or one year af t er t he enquir y int o t he r et ur n was closed. Wher e t he assessment ar ises due t o an enquir y, t his ext ension does not apply if t he claim is ir r evocable or t her e has been f r audulent or negligent conduct .
C5.12 Group relief
Clear inst r uct ions on gr oup r elief claims ar e set down in Par as 66 t o 77 of Sch 18 FA 1998. Par a 67 Sch 18 The claim has t o be made on t he claimant company’s tax return. FA 1998
I t must specify the amount claimed, t he name of the surrendering company, Par a 68 whet her any of t he companies ar e not r esident in t he UK dur ing t he account ing Sch 18 FA 1998 per iod of t he sur r ender ing company t o which t he sur r ender r elat es and t he accounting period of t he claimant t o which t he claim r elat es.
A claim can be made f or less t han t he amount available. The claim will be Par a 69 Sch 18 ineffective if made for more than the amount available. Wher e t her e is mor e FA 1998 t han one claim and t he t ot al exceeds t he amount available, t he Revenue can det er mine which claims ar e inef f ect ive.
A claim r equir es t he written consent of the surrendering company f or a gr oup Par a 70 r elief claim and t he wr it t en consent of each member of a consor t ium in t he case Sch 18 FA 1998 of a consor t ium r elief claim.
Claims will be ineffective unless they are accompanied by the written consent.
To be ef f ect ive t he wr it t en consent must specif y: Par a 71 Sch 18 • The name of t he sur r ender ing company; FA 1998 • The name of t he claimant ; • The amount ; • The account ing per iod of t he sur r ender ing company t o which t he claim r elat es; • The t ax dist r ict r ef er ences of t he sur r ender ing and claimant company.
Not ices of consent can be wit hdr awn and r eplaced by anot her not ice, they Par a 73 Sch 18 cannot be amended. The not ice of wit hdr awal has t o have t he wr it t en consent FA 1998 of t he claimant t o t he wit hdr awal unless it ar ises due t o a r educt ion in t he amount available f or r elief . The claimant must amend it s t ax r et ur n f or t he per iod of t he claim t o r ef lect t he wit hdr awal.
134 Principles of Business Taxat ion ‘Finance Act 2006’
The sur r ender ing company must amend it s t ax r et ur n if t he not ice of consent is given af t er it has f iled t he r et ur n. I f , as a r esult a r educt ion ar ises in a f ut ur e account ing per iod in r espect of losses car r ied f or war d, t hat r et ur n must also be amended.
A claimant company can only withdraw a claim for group relief by amending its tax return. I t cannot amend t he claim. I t can only be wit hdr awn and r eplaced.
The time limit f or making and wit hdr awing gr oup r elief claims is whichever is t he Par a 74 Sch 18 latest of t he f ollowing dat es: FA 1998 • Fir st anniver sar y of t he f iling dat e of t he claimant; • 30 days af t er complet ion of an enquir y int o t he r et ur n; • 30 days af t er t he issue of an amended self assessment f ollowing t he complet ion of an enquir y; • 30 days af t er t he set t lement of an appeal against such an amendment ; • such lat er t ime as t he Revenue allow.
Wher e t he amount available f or sur r ender is r educed, t he sur r ender ing company Par a 75 has 30 days t o wit hdr aw and r e-issue t he consent t o sur r ender , sending copies t o Sch 18 FA 1998 t he Revenue and each claimant company.
I f t he sur r ender ing company f ails t o do so, t he Revenue can give not ice t o t he sur r ender ing company as t o how t he r educed gr oup r elief will be sur r ender ed sending a copy of t he not ice t o each claimant company. The sur r ender ing company has 30 days in which t o appeal in wr it ing against any such not ice issued by t he Revenue. The claimant company on r eceipt of t he new sur r ender or Revenue not ice must amend t heir t ax r et ur n.
Wher e t he wit hdr awal of consent (or a new consent ) r esult s in a company becoming char geable t o t ax, and t hat t ax r emains unpaid af t er six mont hs af t er t he t ime limit f or claims by t hat company, t he Revenue can issue an assessment in t he name of t hat company or any company t hat has obt ained gr oup r elief as a r esult of t he sur r ender . The Revenue have t wo year s t o issue t he assessment . The assessment cannot be mor e t han t he lower of t he t ax unpaid or t he t ax saved by t he ot her company r eceiving group r elief . The company so assessed is ent it led t o r ecover t he amount plus int er est on unpaid t ax under s.87 TMA 1970 f r om t he company t hat f ailed t o pay t he t ax.
The Revenue can issue an assessment t o r ecover any excessive gr oup r elief Par a 76 claimed. This does not af f ect t heir abilit y t o issue a discover y assessment . Sch 18 FA 1998
Cor por at ion Tax Self Assessment (CTSA) 135
C5.13 Claims in respect of overseas losses of non resident companies Par a 77A Sch18 FA 1998
The company must st at e t he Eur opean Economic Ar ea (EEA) amount and t he r elief being claimed – see lat er in your cor por at ion t ax st udies f or how t his is calculat ed.
Ref er ences t o t he sur r ender ing companies accounting period will be to the deemed account ing per iod as def ined by Sch 18A I CTA 1988.
I n t he case of over seas losses of a non r esident company t he consent t o sur r ender is t o be given t o t he of f icer t o whom t he claimant company makes it s r et ur n by t he claimant company not t he sur r ender ing company.
I f t he sur r ender ing company is not wit hin the charge to I ncome or Corporation Tax t he consent does not have t o cont ain det ails of it s t ax r ef er ence number .
Any wit hdr awal of consent t o sur r ender and any new sur r ender ar e t o be given t o t he of f icer of t he board of t he claimant company by t he claimant company.
Any not ice cont aining dir ect ions by an officer of HMRC is to be given to the claimant company.
Any appeal under Par a 75 Sch 18 FA 1988 can be brought by t he claimant company.
A not ice t o pr oduce document s f or t he pur poses of an enquir y under Par a 27 Sch 18 FA 1998 will be given t o t he claimant company.
C5.14 Simplified arrangements for group relief SI 1999/ 2975 Under t he simplif ied ar r angement s, t he gr oup makes an applicat ion t o t he t ax of f ice t hat deals wit h t he authorised company ident if ying all t he companies t o be cover ed by t he ar r angement s by giving t ax r ef er ences and t he names of t ax of f ices f or each one and suf f icient det ail on each one t o ver if y t hat t hey ar e a gr oup company. The applicat ion is made by t he aut hor ised company and signed by all the other companies (the authorising companies), st at ing t hat t hey will be bound by t he ar r angement s. The applicat ion must include an example of t he gr oup r elief schedule t hat t he aut hor ised company will use in t he f ut ur e.
Once t he applicat ion is submit t ed, t he aut hor ised company cannot implement t he ar r angement s f or three months unless t he Revenue give t heir consent at an ear lier dat e. The Revenue can, wit hin t he t hr ee mont hs, accept t he applicat ion but exclude cer t ain companies if t hey t hink t hey have not complied wit h all t heir obligat ions t o f ile r et ur ns and pay t ax.
136 Principles of Business Taxat ion ‘Finance Act 2006’
The Revenue can r ef use t he applicat ion wit hin t hr ee mont hs if t hey t hink one or mor e companies is not a gr oup company or t hey have not complied wit h t heir obligat ions t o f ile r et ur ns and pay t ax. The applicat ion can also be r ef used if it is not t he case t hat all or subst ant ially all t he companies’ t ax r et ur ns ar e dealt wit h in t he same t ax of f ice or t he specimen gr oup r elief schedule is not adequat e.
At any t ime t he Revenue can exclude companies which it believes ar e not gr oup companies or have not complied wit h t heir obligat ions.
Under t he ar r angement s, t he claim for group relief is made by the authorised company and does not have to include a consent to surrender if the aut hor ised company gives aut hor it y t o t he claim being made. This aut horit y has t o be included in t he t ax ret urn of t he aut hor ising company f or which t he claim is made and be signed by t he aut hor ised per son.
The aut hor ised company must f r om t ime t o t ime pr ovide a group relief schedule t o t he Revenue cont aining suf f icient inf or mat ion f or t he making of r et ur ns f or it self and t he aut hor ising companies as r egar ds making and wit hdr awing gr oup r elief claims. The st at ement must cont ain t he same det ails as list ed above concer ning t he det ails of t he claim and t he amount sur r ender ed. I t must also include det ails showing t he ef f ect on each company’s self assessment and det ails of any of t he company’s t ax r et ur ns t hat ar e under enquir y. I f suf f icient det ail is not shown in t he st at ement it is inef f ect ive.
An aut hor ising company r emains liable f or any er r or s in claims or t ax r et ur ns.
Bot h t he aut hor ised company and t he Revenue can give not ice in wr it ing at any t ime t o t he ot her t er minat ing t he ar r angement s f r om t he dat e of t he not ice.
The aut hor ised company can at any t ime give not ice in wr it ing excluding an aut hor ising company f r om t he ar r angement s f r om t he dat e of t he not ice.
C5.15 Capital allowances claims
Claims must be made in t he t ax r et ur n. They must specif y t he amount claimed Par a 79 which must be quant if ied. Sch 18 FA 1998
Claims can be amended or wit hdr awn only by amending t he t ax r et ur n.
The t ime limit f or making, amending or wit hdr awing claims is t he lat er of : Par a 82 Sch 18 • Fir st anniver sar y of t he f iling dat e f or t he t ax r et ur n FA 1998 • 30 days af t er an enquir y int o t he r et ur n is complet ed • I f t he r et ur n is amended by t he Revenue f ollowing an enquir y, 30 days af t er t he not ice of amendment is issued.
Cor por at ion Tax Self Assessment (CTSA) 137
• I f an appeal is br ought against such an amendment 30 days af t er t he appeal is f inally det er mined. • Such lat er t ime as t he Revenue allow.
The time limit otherwise applying t o amendment of a company’s t ax r et ur n does not apply to an amendment to the extent it relates to capital allowances.
Ref er ences t o an enquir y int o t he r et ur n above do not include an enquir y r est r ict ed t o a pr evious amendment making or wit hdr awing or amending a capit al allowances claim.
Wher e a claim r esult s in a r est r ict ion t o capit al allowances available f or anot her Par a 83 Sch 18 account ing per iod f or which t he r et ur n has been deliver ed, t he company has 30 FA 1998 days within which to make amendments to the other tax return. I f it fails to do so t he Revenue may, by not ice in wr it ing, amend t he r et ur n t o make it consist ent wit h t he amount available by way of capit al allowances. The company can br ing an appeal against such a not ice by t he Revenue wit hin 30 days of t he not ice being issued. The t ime limit s ot her wise applicable t o amending a r et ur n do not pr event t hese amendment s.
C5.16 Claims not made in the return Sch 1A TMA 1970
Claims have to be made to the Board in such form as the Revenue may determine. The f or m will pr ovide f or a declaration that all information is correctly stated t o t he best belief of t he per son making t he claim.
Claims may r equir e: • A st at ement of t he amount of t ax r equir ed t o be dischar ged or r epaid. • Such inf or mat ion r easonably r equir ed t o det er mine if t he claim is cor r ect . • Deliver y of account s and document s r easonably r equir ed.
Schedule 18 also cont ains r equir ement s r elat ing t o t he keeping of r ecor ds, amendment of r et ur ns (9 mont hs Revenue, 12 mont hs t he company), power s t o enquir e int o a r et ur n, power t o call f or document s but wit h r ight of appeal.
I f a claim is made out side a r et ur n, wit hin t he t ime limit s f or amending t he r et ur n, it is t r eat ed as an amendment t o t he r et ur n. We nor mally see claims out side r et ur ns wher e t her e is a six year t ime limit f or t he return.
C5.17 Duty to keep and preserve records Par a 21&22 Sch 18 FA 1998 The company must keep such r ecor ds r equir ed t o allow it t o f ile a correct and complete return and t o pr eser ve t hose r ecor ds f or six years f r om t he end of t he per iod f or which t he company may be r equir ed t o deliver a t ax r et ur n.
138 Principles of Business Taxat ion ‘Finance Act 2006’
Wher e t he company is r equir ed t o deliver a t ax r et ur n bef or e t he end of t hat six year per iod t he r ecor ds have t o be kept unt il t he lat er of : (i) t he dat e an enquir y int o t he r et ur n is complet ed (ii) if t her e is no enquir y, t he dat e t he Revenue can no longer enquir e int o t he r et ur n.
I f t he company is r equir ed by not ice t o deliver a r et ur n out side t hat six year per iod and it st ill has t hose r ecor ds t hen t o t he lat er of t he same above dat es.
The r ecor ds t hat must be kept ar e (i) all r eceipt s and expenses ar ising in t he cour se of t he t r ade and det ails of t he mat t ers t o which t hey relat e; (ii) all sales and pur chases of goods f or a company dealing in goods; (iii) all suppor t ing document s must also be kept .
C5.18 Conclusiveness of amounts in the return Par a 88 Sch 18 FA 1998 The t ax payable by a company making a r et urn and t he t ax liabilit y of anot her company f or any account ing per iod will be t r eat ed as no longer alterable on t he later of t he complet ion of : (i) 12 mont hs f r om t he f iling dat e (ii) 30 days af t er t he complet ion of an enquir y int o t he r et ur n (iii) 30 days af t er amendment t o t he r et ur n f ollowing an enquir y (iv) 30 days af t er t he det er minat ion of an appeal against an assessment f ollowing an amendment of t he self assessment by t he Revenue.
Wher e amendment s have been made t o t he r et ur n out side 12 mont hs f r om t he f iling dat e, amount s af f ect ed by t he amendment will no longer be alt er able on t he lat er of t he end of t he per iod int o which not ice of enquir y in t he r et ur n may be given as a r esult of t he amendment , t he end of t he per iod int o which an appeal can be made f ollowing an amendment t o t he r et ur n or t he det er minat ion of an appeal against such an amendment .
Cor por at ion Tax Self Assessment (CTSA) 139
Answer 1
a) 31.3.08
For t he CAP ending 31 Mar ch 2007, t he r et ur n must be f iled by 31 March 2008. The not ice was issued bef or e t he st ar t of t he 3 mont hs leading up t o t he f iling dat e and t her ef or e t he nor mal due f iling dat e is r elevant .
b) 24.6.08
For t he CAP ending 31 May 2007, t he not ice was issued wit hin t he 3 mont hs leading up t o t he nor mal f iling dat e of 31 May 2008. Ther ef or e, as t he company will always have a minimum of 3 mont hs f r om t he r eceipt of t he not ice, t he due f iling dat e is 24 June 2008.
Answer 2
(a) (b) Cor r ect ion of obvious er r or s 31.10.08 31.3.08 Enquir y deadline 31.3.09 31.7.08
I n (a) t he ret urn is f iled on t ime. Ther ef or e, t he Revenue has 9 mont hs f r om t he act ual f iling dat e t o cor r ect any obvious errors. That is 31 Oct ober 2008. The enquir y deadline r uns exact ly one year f r om t he due f iling dat e, which is 31 March 2009.
I n (b) t he r et ur n is f iled a mont h lat e, t he Revenue will have 9 mont hs f r om t he act ual f iling dat e t o cor r ect any obvious er r or s, which t akes us t o t he 31 Mar ch 2008 and, will have one year f r om t he next quar t er dat e t o st ar t an enquir y. The next quar t er dat e is 31 J uly 2007, add 12 mont hs, t hat t akes us t o 31 J uly 2008.
140 Principles of Business Taxat ion ‘Finance Act 2006’
SUMMARY – CORPORATION TAX SELF ASSESSMENT (CTSA)
Companies ar e r equir ed t o f ile t heir r et ur n and st at ut or y account s 12 mont hs af t er t he end of t he account ing per iod (or 3 mont hs af t er t he not ice t o submit a r et ur n has been issued, if lat er ).
Wher e t he company has a long per iod of account , t her e ar e t wo char geable account ing per iods and t wo r et ur ns, but bot h r et ur ns ar e due on t he same dat e.
Companies have t o self assess t he amount of t ax due.
Ther e is a st at ut or y obligat ion t o not if y char geabilit y wher e a company f ir st comes wit hin t he char ge t o t ax or comes back int o t he char ge. Cer t ain pr escr ibed inf or mat ion must also be pr ovided.
The Revenue have t he r ight t o r aise discover y assessment s if t ax has been lost due t o t he f r audulent or negligent conduct of t he company or t he Revenue have not been pr ovided wit h suf f icient inf or mat ion t o allow t hem t o make a cor r ect assessment of t he company’s pr of it s.
Companies can make er r or or mist ake claims if t hey t hink t hey have over paid t ax on an ear lier r et ur n. However , no r elief is available if t he r et ur n was made in accor dance wit h pr act ice t hen pr evailing.
Schedule 18 FA 1998 lays down clear guidelines on how claims ar e t o be made and amended.
Ther e is a simplif ied pr ocedur e available f or gr oup r elief claims.
Companies must keep r ecor ds t o suppor t t heir t ax r et ur ns.
C6: PAYMENT OF CORPORATION TAX
This chapt er looks at t he payment of cor por at ion t ax cover ing in par t icular : - t he due dat e f or payment of a company’s cor por at ion t ax liabilit y; - payment by inst alment s; - gr oup payment ar r angement s; - gr oup t ax sur r ender s.
C6.1 Introduction
Ther e ar e t wo t ypes of company f or payment pur poses; t hose who pay t ax at t he f ull r at e and t hose who do not .
Small companies (including mar ginal r elief companies) ar e r equir ed t o pay all of t heir cor por at ion t ax 9 months and 1 day af t er t he end of t he char geable account ing per iod.
For example, wher e a char geable account ing per iod ends on 31 December 2006, t he due and payable dat e f or cor por at ion t ax is 1 Oct ober 2007.
Large companies ar e r equir ed t o pay their tax by quarterly instalments.
Lar ge companies ar e def ined as t hose who have not ional pr of it s (PCTCT + FI I ) in excess of £ 1,500,000. This f igur e is adj ust ed f or shor t account ing per iods and associat ed companies.
I n summar y, companies t hat pay t ax at t he f ull 30% rat e pay t ax by inst alment s. All ot her companies pay t ax 9 mont hs and one day af t er t he char geable account ing per iod.
C6.2 Payment of tax by instalments SI 1998/ 3175
Companies who paid corporation tax at the full rate in the previous accounting period will have an obligat ion t o pay t ax by inst alment s.
The first year that a company is large, there is no need to pay tax by Reg 3 STI 1998/ 3175 instalments, unless profits exceed £10 million.
The £ 10 million is divided among all the associated companies, and is reduced for accounting periods which are less than 12 months long. However , t he number of associat ed companies is ar r ived at by looking at t he associat ed companies at t he end of t he immediately preceding account ing per iod.
Full r at e companies whose CT liability is below £10,000, are exempt f r om Reg 3 quar t er ly payment s. These could be companies t hat pay t ax at 30%, but ar e par t STI 1998/ 3175 of a ver y lar ge gr oup, so t heir individual liabilit y is r elat ively small. 142 Principles of Business Taxat ion ‘Finance Act 2006’
The inst alment payment s ar e due as f ollows: Reg 5 STI 1998/ 3175
(i) The first payment is due 6 months plus 13 days from the start of the account ing per iod;
(ii) Subsequent payment s ar e due 3 months after t he pr evious inst alment ; (iii) Final payment is due 3 months plus 14 days from the end of the char geable account ing per iod.
All t ax due by inst alment s must be paid by t he due dat e f or t he f inal payment , ot her wise int er est will r un. Illustration 1
Assume we have a char geable account ing per iod f or t he year ending 31 Mar ch 2007.
The first instalment will be due 6 months plus 13 days from the start of this account ing per iod, i.e. 14 Oct ober 2006.
The next inst alment is due 3 mont hs lat er , i.e. 14 J anuar y 2007.
The f ollowing inst alment is due 3 mont hs af t er t he pr evious, i.e. 14 Apr il 2007.
The f ollowing inst alment is due 3 mont hs af t er t he pr evious, i.e. 14 J uly 2007.
As t his is t he f inal inst alment , it cannot be lat er t han 3 mont hs and 14 days f r om t he end of t he account ing per iod, i.e. 14 J uly 2006. For a t welve mont h account ing per iod t he f inal inst alment will f all 3 mont hs and 14 days af t er t he end of t he account ing per iod. Example 1
Assume we have a chargeable accounting period for the year ending on 31 July 2007. What ar e t he inst alment dat es?
C6.3 Amount due by instalments
The amount of each inst alment is based on t he corporat ion t ax liabilit y of t he current year, even t hough t he company at t he t ime of making t he first inst alment is only half way t hr ough t he account ing per iod.
The syst em was init ially phased in, such t hat in t he f irst 3 years of CTSA not all of t he t ax was due by inst alment s but since J uly 2002, lar ge companies have been paying 100% of t heir cor por at ion t ax by inst alment s. Payment of Corporat ion Tax 143
Each inst alment is calculat ed using t he f or mula: Reg 5(5) STI 1998/ 3175 3 x estimated corporation tax liability N
wher e N is t he number of mont hs in t he account ing per iod.
The f ir st t hing we must do is t o ident if y how many instalments t here will 3 act ually be, using t he f or mula. For a 12 mont h account ing per iod, t he N 3 3 3 3 inst alment s will be t hs, t hs, t hs and ths, of t he t ax due by 12 12 12 12 inst alment s. This gives a t ot al of f our inst alment s, which ar e due.
For a 10 mont h account ing per iod, f or example, t he inst alment s will be as f ollows, 3 3 3 9 t hs, t hs, t hs (which gives us t hs) and t he f inal inst alment will be j ust 10 10 10 10 1 3 th. I f we pay anot her ths we will act ually have paid t oo much. This once 10 10 again gives us f our inst alment s.
3 3 2 For an 8 mont h account ing per iod t he inst alment s due will be t hs, t hs and 8 8 8 t hs, which gives only t hr ee inst alment s. For a 5 mont h per iod t he inst alment s due 3 2 will be t hs and t hs, which only gives t wo inst alment s. 5 5
Once we have est ablished how many inst alment s ar e due we then need to consider the amounts. The impor t ant t hing is t o look at when t he account ing per iod ends.
Illustration 2
Assume we have a char geable account ing per iod f or t he year ending 31 March 2007, wit h prof it s of £ 2 million. This gives us a cor por at ion t ax liabilit y at 30% of £ 600,000. 3 Each inst alment amount will be £ 600,000 x = £ 150,000. 12 The f ir st inst alment will be due f or payment on t he 14 Oct ober 2006. The next 3 inst alment s will each be £ 150,000 due on 14 J anuar y, 14 Apr il and 14 J uly 2007. Example 2
Consider a char geable account ing year ended 31 J uly 2007, wit h prof it s of £ 1.75 million. Show t he amount of t ax due on each of t he appr opr iat e dat es.
144 Principles of Business Taxat ion ‘Finance Act 2006’
Illustration 3
Consider an 8 mont h account ing per iod ended 31 December 2006 and a t ax liabilit y of £ 800,000. Our f irst st ep is t o work out how many inst alment s t her e 3 3 2 act ually ar e. Her e t his will be t hs, t hs and t hs, which is t he 3 inst alment s. 8 8 8
The f ir st inst alment is due 6 mont hs plus 13 days f r om t he st ar t of t he account ing per iod, which t akes us t o 14 November 2006. The next inst alment is due 3 mont hs lat er , which is 14 Febr uar y 2007.
The f inal inst alment cannot be later than 3 months plus 14 days f r om t he end of t he account ing per iod, which is 14 Apr il 2007. I f we wer e t o use t he t hr ee months rule we would go to 14 May 2007. This is not allowed so the final inst alment f alls on 14 Apr il 2007. Summar y of Payment s:
I nst alment Due Wor king £ 1 14.11.06 £800,000 x 3/8 300,000 2 14.2.07 as above 300,000 3 14.4.07 £800,000 x 2/8 200,000 £800,000 Example 3
Consider a 6 mont h account ing per iod ending on 30 June 2007, wit h a t ax liabilit y due of £ 100,000.
Calculat e t he amount s and due dat es of t he t ax payable.
C6.4 Group payment arrangements s.36 FA 1998 & Revenue Wher e one or mor e companies in a 51% group (par ent wit h 51% subsidiar ies and Manuals t heir 51% subsidiar ies) ar e liable t o pay t ax by inst alment s, t hey may nominat e a company t o deal wit h t he gr oup payment ar r angement s f or t he gr oup. They complet e a gr oup payment ar r angement s document list ing all t he companies who ar e t o par t icipat e and submit it t o t he Revenue t wo mont hs bef or e t he f ir st inst alment payment is due by any gr oup member .
“Group” is def ined in sect ion 36 FA 1998 as a company and all it s 51 per cent s.36(4) subsidiar ies, and t heir 51 per cent subsidiar ies, and so on. FA 1998
The applicat ion must st at e t he st ar t and end dat es of t he f ir st per iod t o which t he ar r angement s ar e t o apply. The ar r angement s will t hen apply aut omat ically t o subsequent per iods of account unless and unt il t he companies not if y t hat t hey t hat wish t o t er minat e it or t he Revenue t er minat e it .
The Revenue will t er minat e t he ar r angement s if :
Payment of Corporat ion Tax 145
• any of t he par t icipat ing companies f ails t o meet it s obligat ions t o pay cor por at ion t ax and f ile it s company t ax r et ur n f or any account ing per iod;
• t he nominat ed company br eaks any of its obligat ions under t he ar r angement ;
• t hey have r eason t o believe t hat any member of t he gr oup of companies (including t hose not cover ed by t he same or any gr oup payment ar r angement ) may become liable t o t ax under Sect ions 767A or 767AA I CTA (change in company owner ship wit h CT r emaining unpaid).
Nor mally t he Revenue will only t er minat e t he ar r angement s in cases wher e t her e has been a ser ious f ailur e or br each or a pat t er n of non-compliance, not f or minor mat t er s.
I f a gr oup has an ar r angement t er minat ed, it will not be ent it led t o r egist er a new ar r angement f or t he next Per iod of Account .
The nominat ed company under t akes t o pay t he cor por at ion t ax liabilit ies of t he par t icipat ing companies f or account ing per iods f alling wit hin t he per iods of account cover ed by t he ar r angement s (t he r elevant account ing per iods). I t is up t o t he nominat ed company t o det er mine how much t o pay and when t o make payment s. Payment r equest s or r eminder s will not be issued.
“Liabilit ies” means cor por at ion t ax and any liabilit ies under Sect ion 419 and Sect ion 747 I CTA (loans t o par t icipat or s in close companies, and cont r olled f or eign companies).
The ar r angement s apply f or a “per iod of account ” which is nor mally t he account ing per iod of each of t he par t icipat ing companies.
Gener ally, t he par t icipat ing companies should all have account ing per iods which ar e ident ical t o t he per iod of account .
However , t he ar r angement document also allows a company in a gr oup t o t ake par t in a gr oup payment ar r angement if it s account ing per iods dif f er f r om t he per iod of account under some cir cumst ances. The liabilit ies f or an account ing per iod of such a company can be included in an ar r angement f or a per iod of account if
• t he account ing per iod st ar t s wit hin t he per iod of account , and ends on t he same day as t he nominat ed company’s account s; or
• t he account ing per iod st ar t s on or af t er , but ends bef or e t he end of t he per iod of account , and is f ollowed by anot her (shor t ) account ing per iod ending on t he same day as t he per iod of account .
This will allow newly-f or med and newly-acquir ed companies t o be included wit hin a gr oup payment ar r angement .
146 Principles of Business Taxat ion ‘Finance Act 2006’
I t is possible t o set up separ at e gr oup payment ar r angement s f or dif f er ent sub- set s of t he gr oup. But no one company can par t icipat e in mor e t han one gr oup payment ar r angement in r espect of any one of it s account ing per iods.
The par t icipat ing companies can change over t ime as companies j oin and leave t he gr oup.
The nominat ed company must r emove f r om t he gr oup payment ar r angement any par t icipat ing company, ot her t han t he nominat ed company, which ceases t o be a member of t he group, or which does not have an account ing period which ends on t he same day as t he per iod of account .
The r evenue can r emove a company f r om t he ar r angement if it t ur ns out never t o have been a member of t he group, or if t he nominated company f ails t o f ulf il it s obligat ion t o do so.
For ever y per iod of account cover ed by a gr oup payment ar r angement , t her e is a “Closing Date”. This is t he dat e at which t he nominat ed company’s liabilit ies ar e f ixed, and af t er which it must say how t he payment s it has made ar e t o be allocat ed t o t he individual par t icipat ing companies.
The closing dat e is t he lat er of
• whichever f iling dat e is t he lat est , out of all t he f iling dat es of t he par t icipat ing companies f or r et ur ns f or r elevant account ing per iods, and
• t he day when t he Revenue r eceive t he last of t hose r et ur ns (or make a det er minat ion of t ax in t he absence of a r et ur n).
The amount payable by t he nominat ed company in r espect of each r elevant account ing per iod of t he par t icipat ing companies will not be af f ect ed by changes in t heir liabilit y occurring af t er t he closing dat e.
Ther ef or e adj ust ment s made t o t he liabilit y of an individual par t icipat ing company (f or example, in r espect of int er est or penalt ies, or as a r esult of an enquir y int o t he company’s r et ur n) will be t he r esponsibilit y of t he individual par t icipat ing company, not t he nominat ed company.
The nominat ed company can claim a r epayment .
This might be t he case wher e, f or example, t he f or ecast of pr of it s at gr oup level has f allen as a r esult of t he unexpect ed loss of business t o a new compet it or , or wher e a par t icular ly pr of it able company has been sold out of t he gr oup dur ing t he r elevant account ing per iod.
No st eps will be t aken bef or e t he closing dat e, t o r ecover liabilit ies f r om t he par t icipat ing companies f or r elevant account ing per iods.
The Revenue st ill have t he r ight t o r ecover out st anding liabilit ies f r om t he individual par t icipat ing companies, but only after t he closing dat e. Payment of Corporat ion Tax 147
Af t er t he closing dat e, t he Revenue will send a not ice of t heir calculat ion of t he amount t he nominat ed company should have paid under t he ar r angement , and any balance out st anding or over paid.
This calculat ion will be f inal and conclusive, and binding on t he nominat ed company.
The nominat ed company t hen wit hin 30 days ir r evocably specif ies in wr it ing how payment s made under t he agr eement should be appor t ioned amongst t he par t icipat ing companies. Payment s t o be appor t ioned will be net of any r epayment s made, and of any ot her appor tionment s alr eady made (f or example t o a depar t ing company).
I f t he nominat ed company f ails t o make t he appor t ionment t he Revenue will make an appor t ionment inst ead in accor dance wit h t he liabilit ies of t he part icipat ing companies as shown on t heir r et ur ns, t o t he ext ent t hat t he aggr egat e amount paid is enough t o cover t hose liabilit ies giving not ice in wr it ing t o t he nominat ed company of t he appor t ionment . The nominat ed company has t he r ight t o amend t his appor t ionment if it does so wit hin 30 days f r om t he dat e of t he not ice.
The Revenue can r eappor t ion payment s among t he par t icipat ing companies if t he liabilit ies of one or mor e of t hem r emain out st anding af t er t he nominat ed company’s appor t ionment . The nominat ed company cannot amend such a r eappor t ionment .
This will only be done if the nominat ed company’s appor t ionment leaves an under payment on t he account of a par t icipat ing company and t he Revenue cannot r ecover t he shor t f all f r om t hat company.
Payment s made by t he nominat ed company on behalf of t he par t icipat ing companies ar e deemed t o have been made by t hose companies in t he amount s f inally appor t ioned t o t hem, and on t he dat es t hey wer e made by t he nominat ed company.
Payment s will be deemed t o be appor t ioned (t o t he ext ent t hey have not been r epaid) t o t he par t icipat ing companies in t he f ollowing or der : 1. t o t hose which have not incur r ed a lat e-filing penalt y, or have only incur r ed a f ixed-r at e penalt y; 2. t o t hose which have incur r ed a t ax-r elat ed penalt y at t he lower r at e of 10%; 3. t o t hose which have incur r ed a t ax-r elat ed penalt y at t he higher r at e of 20%, eit her by f ailing t o f ile a r et ur n, or by filing it more than two years af t er t he end of t he period f or which it is required.
This ensur es t hat a company t hat has f iled it s r et ur n lat e, and is t her ef or e liable t o a t ax-r elat ed penalt y, cannot have t he amount of t hat penalt y r educed as a r esult of t he nominat ed company’s appor t ionment .
148 Principles of Business Taxat ion ‘Finance Act 2006’
C6.5 Group tax surrenders s.102 FA 1989 This sect ion r elat es t o gr oups which have not ent er ed int o gr oup payment ar r angement s.
A company t hat is due a r ef und can sur r ender it to a fellow group company. A gr oup her e is as f or gr oup r elief . The companies must have t he same account ing per iod and have been member s of t he gr oup t hr oughout t he per iod f r om t he st ar t of t he account ing per iod t o t he day t he not ice is given. The companies have t o give j oint not ice in wr it ing of t he sur r ender , st at ing t he name and t ax r ef er ence of bot h companies and t he t ype and amount of t he r ef und sur r ender . The sur r ender can apply t o t he whole or par t of a r ef und.
The r ecipient company is t r eat ed as having paid t he amount sur r ender ed on t he lat er of t he dat e it was paid or t he due dat e of payment . The sur r ender ing company is t r eat ed as r eceiving a r ef und on the same day. For instalment payment s t he t ax is t r eat ed as being paid t he lat er of t he dat e it was paid by t he sur r ender ing company and t he due dat e f or t he f ir st inst alment .
I nterest paid by the surrendering company is treated as if it had been paid by t he r ecipient company. Payment s bet ween t he companies in r espect of t he sur r ender ar e ignor ed f or t ax and will not be t r eat ed as dist r ibut ions.
Payment of Corporat ion Tax 149
Answer 1
14 February 2007 14 May 2007 14 August 2007 14 November 2007
Answer 2
Tot al t ax due: £ 1,750,000 x 30% = £ 525,000
Each inst alment will be
3 £ 525,000 x t hs = £ 131,250 12
Due on 14.2.07 £ 131,250 14.5.07 £ 131,250 14.8.07 £ 131,250 14.11.07 £ 131,250
Answer 3
3 How many inst alment s? 2 of t hs each 6
I nst alment Due £
1 14.7.07 £ 100,000 x 3/ 6 50,000 2 14.10.07 as above 50,000 ______Total £100,000
150 Principles of Business Taxat ion ‘Finance Act 2006’
SUMMARY – PAYMENT OF CORPORATION TAX
Companies paying t ax at t he f ull r at e of 30% ar e r equir ed t o pay t heir cor por at ion t ax by inst alment s.
Companies who do not pay t ax at t he f ull r at e ar e not r equir ed t o pay by inst alment s. I nst ead any t ax is due 9 mont hs and one day af t er t he end of t he account ing per iod.
Wher e t he t ax due is under £ 10,000, no inst alment s will be r equir ed.
A company is not r equir ed t o pay in inst alment s f or t he f ir st year it becomes lar ge pr oviding t he pr of it s ar e less t han £ 10 million (t welve mont h limit ).
For companies who do pay at t he f ull r at e t he r equir ed inst alment s ar e due on t he 14th of mont hs 7,10, 13, and 16 count ing f r om t he st ar t of t he AP.
I f t he t ax is not paid on t he due dat e, int er est will be char ged f r om t he due dat e t o t he dat e bef or e it is paid.
Wher e t her e is a 51 % gr oup t he gr oup can apply f or t he nominat ed company t o make all payment s of t ax f or t he gr oup and allocat e t he payment s af t er t he closing dat e.
I f t he gr oup payment ar r angement s ar e not used amount s of t ax over paid can be sur r ender ed wit hin a gr oup r elief gr oup.
C7: INTEREST ON LATE PAID TAX
This chapt er looks at int er est and in par t icular it cover s: - int er est on lat e paid t ax and r epayment s; - t he ef f ect of amount s car r ied back.
C7.1 Introduction
I nt er est r uns from the due date of payment to the day before the actual s.97A TMA 1970 date of payment of t he t ax wher e cor por at ion t ax is paid lat e. s.826 I CTA 1988 This applies t o all payment s of cor porat ion t ax – whet her t he company pays by inst alment s or not . So small companies, who ar e r equir ed t o pay t heir t ax 9 mont hs and 1 day af t er t he end of t he account ing per iod, will also be char ged int er est wher e t hey pay t hat t ax lat e.
Problems ar e exper ienced par t icular ly by lar ger companies, as tax due by instalments is based on the tax liability of the current year, yet t he payment s ar e made dur ing t he year . A company will t her ef or e have t he pr oblem of estimating its tax bill, which could well change dur ing t he year , so what t hey pay may not ref lect t heir act ual liabilit y. I f t hey do not pay enough, int er est will r un. I f t hey pay t oo much, t hey will get r epayment int er est , but at a lower r at e.
Illustration 1
Guesswor k Limit ed est imat es it s pr of it s f or t he year ended 31 May 2007 t o be £ 2 million when it makes it s f ir st inst alment of cor por at ion t ax.
As this is a 12 month CAP each instalment will be 3/12 x 100% = 25%. The amount of t ax due on 14.12.06 will t her ef or e be:
£ 2,000,000 x 30% = £ 600,000 x 25% = £ 150,000
At t he beginning of Mar ch t he company wins a maj or new cont r act which is likely t o incr ease t he company' s pr edict ed pr of it f or the year to £ 2.2 million. For its second inst alment due on 14.3.07 t he company would be advised t o make a payment as f ollows:-
£ 2,200,000 x 30% = £ 660,000 x 50% = £ 330,000 Less t ax paid on 14.12.06 (150,000) £180,000
152 Principles of Business Taxat ion ‘Finance Act 2006’
By t he end of t he account ing per iod t he dr af t account s r eveal a t axable pr of it of £ 2.25 million. The company should t her ef or e pay t ax as f ollows on 14.6.07 in r espect of it s t hir d inst alment :
£ 2,250,000 x 30% = £ 675,000 x 75% = £ 506,250 Less tax paid so far (330,000) £176,250
By t he end of August t he company has been audit ed and t he pr of it or iginally ant icipat ed has been r educed t o £ 2.15 million. The company should t her ef or e pay t ax as f ollows on 14.9.07 in r espect of it s f our t h inst alment :
£ 2,150,000 x 30% = £ 645,000 x 100% = £ 645,000 Less tax paid so far (506,250) £138,750
The company pr epar es it s f inal cor por at ion t ax comput at ions by t he end of Febr uar y 2008, which show a f inal t axable prof it of £ 2,190,000.
The company t her ef or e pays t ax as f ollows on 1.3.08:
£2,190,000 x 30% = £657,000 Less tax paid by instalments (645,000) £ 12,000
I t is nor mal f or a company t o keep revising its estimated corporation tax liability in t his way.
Payment s Summar y:
Paid Cumulat ive Due Cumulat ive Under paid/ £ £ £ £ (over paid) 14.12.06 150,000 150,000 164,250 164,250 14,250 14.3.07 180,000 330,000 164,250 328,500 (1,500) 14.6.07 176,250 506,250 164,250 492,750 (13,500) 14.9.07 138,750 645,000 164,250 657,000 12,000 1.3.08 12,000 657,000 ______657,000 657,000
The Revenue will issue an int er est st at ement once t he r et ur n has been submit t ed and t he f inal liabilit y has been calculat ed.
I nt erest on Lat e Paid Tax 153
I nt er est Summar y:
14.12.06 t o 13.3.07 I nt er est charged on £ 14,250 under paid 14.3.07 t o 13.6.07 I nt er est credit on £ 1,500 over paid 14.6.07 t o 13.9.07 I nt er est credit on £ 13,500 over paid 14.9.07 t o 29.2.08 I nt er est charged on £ 12,000 under paid
Assuming a r at e of int er est on under paid t ax of 7% and a r at e of int er est on over paid t ax of 5% t he int er est posit ion can be calculat ed as f ollows: £ 90 245.96 £ 14,250 x 7% x = 365
92 (18.90) £ (1,500) x 5% x 365
92 (170.14) £ (13,500) x 5% x 365
169 387.87 £ 12,000 x 7% x 366
I nt er est due t o t he Revenue £444.79
The Revenue will r aise an interest demand which must be settled within 30 days. I f it is settled late there will be interest charged on t he int er est .
The Revenue have conf ir med t hat t hey will accept payment s of cor por at ion t ax at any t ime so if t he company calculat es and pays it s cor por at ion t ax ear lier t his will st op t he int er est r unning.
Any int er est r eceived will be t axed under Schedule DI I I . Any int erest paid by s.100 FA t he company will be t r eat ed as int er est paid on a non-t r ading loan and can be 1996 deduct ed f r om DI I I income.
C7.2 Effect of carry backs
Wher e losses ar e car r ied back under s.393A(1) and r esult in a r epayment of t ax, t hen f or calculat ing t he int er est on t his r epayment it is treated as tax repaid for the accounting period of the loss unless the repayment arises in respect of an accounting period that falls wholly within the twelve months prior t o t he one in which t he loss ar ose.
154 Principles of Business Taxat ion ‘Finance Act 2006’
I f t he car r y back r educes an amount of unpaid t ax, interest will cease to run from the due date of the period in which the loss was made f or t he amount of t ax unpaid t hat t he carry back negat es. Apar t f r om t his it is ignor ed in calculat ing t he int er est on unpaid t ax except f or an account ing per iod f alling wholly wit hin t he 12 mont hs bef or e t he one in which t he loss ar ose.
For carry back of non-trade deficits on loan r elat ionships t he calculat ion of int er est on under paid or over paid cor por at ion t ax is not af f ect ed except t hat in t he case of under payment s the amount met by the carry back is treated as paid on the due date for the accounting period in which the deficit arose. Ot her wise it is t r eat ed as a r epayment of cor por at ion t ax f or t he account ing per iod in which t he def icit ar ose.
I nt erest on Lat e Paid Tax 155
SUMMARY – INTEREST ON LATE PAID TAX
I nt er est r uns on t ax paid lat e f r om t he due dat e t o t he day bef or e payment .
I nt erest will be paid on overpaid t ax f rom t he due dat e/ dat e paid t o t he day bef or e t he r epayment .
Tax r epaid as a r esult of a loss car r y back is t r eat ed as t ax r epaid f or t he year giving r ise t o t he loss unless t he account ing period of t he carry back f alls wholly wit hin t he t welve mont hs bef or e t hat of t he loss.
Tax repaid as a result of a DI I I def icit car r y back is t r eat ed as a r epayment of corporat ion t ax f or t he year in which t he def icit ar ose.
C8: CTSA PENALTY REGIME
This chapt er examines t he Cor por at ion Tax Self Assessment (CTSA) pr ocedur es r elat ing t o penalt ies.
C8.1 Introduction
The CTSA penalt y r egime has been int r oduced t o ensur e compliance wit h t he var ious CTSA administ r at ive r equir ement s. The penalt y r egime aims t o penalise var ious misdemeanour s. These include late filing of r et ur ns, failure to notify char geabilit y, record-keeping f ailur es and fraudulent or negligent r et ur ns.
C8.2 Late filing of returns
All companies ar e required to file their return within 12 months of the end of the period of account (POA) which is t he company' s f inancial r epor t ing per iod i.e. t he per iod f or which t he company has made up it s set of account s. I n most sit uat ions t he per iod of account and t he char geable account ing per iod will be t he same.
Ther e ar e t wo t ypes of penalt ies f or t he lat e f iling of a r et ur n; a flat rate penalty and a tax geared penalty.
A flat rate penalt y of £100 will be levied aut omatically by t he Revenue (subj ect Par a 17 Sch 18 t o a 7 day period of grace) wher e t he r et ur n is up to three months late. The FA 1998 £ 100 penalt y st ands r egar dless of t he level of pr of it s. and ESCB46
The penalt y it self incr eases t o £200 wher e t he r et ur n is more than 3 months late. These penalt ies ar e incr eased t o £500 and £1,000 if this is the company's third consecutive offence.
As f or the tax geared penalt ies, a 10% penalt y will ar ise if t he r et ur n is filed Par a 18 Sch 18 more than 18 months af t er t he end of t he char geable account ing per iod. The FA 1998 10% will be t aken on any cor por at ion t ax owing at t hat 18 mont h point . This penalt y doubles t o 20% wher e t he r et ur n is filed more than 24 months af ter t he char geable account ing per iod but t his is based on t he tax owing at the 18 month point.
Remember t hat t he end of t he period of account is t he t r igger in r espect of t he flat rate penalties as t hese ar e based on t he filing date but t he end of t he chargeable accounting period t r igger s t he tax geared penalt ies.
CTSA Penalt y Regime 157
Illustration 1
Har r is Limit ed makes up account s f or t he 16 mont hs ended 31 August 2006. This is a long POA f or t ax pur poses and must be split int o t wo separ at e CAPs - one f or t he f ir st 12 mont hs and t hen t he balance of t he per iod.
The company will have 2 CAPs, 2 payment dat es and 1 f iling dat e which we can remember by calling t his t he “2-2-1” rule.
The CAPs are t he 12 m/ e 30 April 2006 and t he 4 m/ e 31 August 2006. This leads t o t wo separ at e payment dat es: t he liabilit y in respect of t he 12 m/ e 30 April 2006 is due on 1 February 2007 and t he liabilit y in r espect of t he 4 mont h per iod is due on 1 J une 2007.
This is on t he assumpt ion t hat t he company is a small company and not liable under t he CTSA inst alment r egime.
Ther e is only one f iling dat e because t his is t r igger ed by t he POA. Bot h r et ur ns ar e due wit hin 12 mont hs of t he end of t he POA so t he due dat e f or t he f iling of bot h t he r et ur ns is 31 August 2007.
Ther e will be penalt ies if Har r is Lt d f ails t o comply wit h CTSA r equir ement s. The £ 100 penalt y will be t riggered if eit her of t he r et ur ns is f iled mor e t han 7 days af t er 31 August 2007. This applies per r et ur n, so t wo r et ur ns f iled lat e means £ 200. Each penalt y it self incr eases t o £ 200 if either of the returns are f iled af t er 30 November 2007, in ot her wor ds ar e over 3 mont hs lat e.
Not e: The Revenue allows a 7 day per iod of gr ace f or f iling t he r et ur n, however t his is by concession.
The penalt y of 10% of t he t ax out st anding is t r igger ed if eit her of t he r et ur ns ar e f iled mor e t han 18 mont hs aft er t he end of t he r elevant CAP:
y/ e 30.4.05 + 18m = 31.10.07 4m/ e 31.8.05 + 18m = 29.2.08
The penalt y of 20% of t ax out st anding is t r igger ed if eit her t he r et ur ns ar e f iled mor e t han 24 mont hs af t er t he end of t he r elevant CAP and will be char geable on any t ax out st anding at t he 18 mont h point - not t he 24 mont h point .
y/e 30.4.06 + 24m = 30.4.08 4m/ e 31.8.06 + 24m = 31.8.08
158 Principles of Business Taxat ion ‘Finance Act 2006’
C8.3 Failure to notify chargeability
For account ing per iods beginning on or af t er 22 July 2004 a penalt y will arise f or companies f ailing t o not if y char geability wit hin t hr ee mont hs of t he st ar t of t heir f ir st account ing per iod or of t hem coming back wit hin t he char ge t o t ax.
The penalty will be £300 for initial failure with a potential penalty of £60 a s.98 TMA 1970 day for continued failure once the initial penalty has been levied.
A penalty of £3,000 can be char ged if incor r ect inf or mat ion is pr ovided s.98 TMA 1970 fraudulently or negligently.
C8.4 Record keeping failures
Companies ar e r equir ed t o keep certain records f or at least 6 years by t he end Par a 21 of t he char geable account ing per iod. These ar e t he same as t he Companies Act Sch 18 FA 1998 r equir ement s and will include: (i) r ecor ds of r eceipt s and expenses, and t he mat t ers t o which t hey relat e; (ii) det ails of all sales and pur chases made in t he cour se of t r ade, wher e t he t r ade involves dealing in goods; and (iii) suppor t ing document s, such as account s, books, voucher s, cont r act s, deeds et c.
The penalt y f or f ailing t o keep t hese r ecor ds is £3,000 per chargeable Par a 23 Sch 18 accounting period. FA 1998
C8.5 Fraudulent or negligent returns
Negligent f or t hese pur poses includes any innocent er r or t hat t he company f ails Par a 20 t o cor r ect wit hout “unr easonable delay”. The penalt y also ext ends t o f r audulent Sch 18 FA 1998 or negligent claims made on t he r et ur n or amendment s t o it .
The penalt y is up to 100% of the tax avoided as a r esult of t he negligence or f r aud on t he r et ur n, i.e. t he dif f er ence bet ween t he t ax t hat should be payable and t he t ax t hat act ually was paid based on that return. This penalty is subject t o mit igat ion based on t he size of t he of f ence, t he degr ee of co-oper at ion and volunt ar y disclosur e of t he er r or giving r ise t o t he under -declar at ion of t ax.
CTSA Penalt y Regime 159
C8.6 Not producing documents
A company f ailing t o pr oduce document s f or t he pur pose of an enquir y is liable: Par a 29 Sch 18 FA 1998 (i) £ 50 penalt y (ii) Wher e t her e is cont inuing f ailur e af t er t he above penalt y f ur t her penalt ies of £ 30 a day if t he penalt y is imposed by a Revenue Of f icer £ 150 a day if it is imposed by t he Commissioner s.
C8.7 Multiple penalties
Wher e t he company r eceives mor e t han one penalt y t hat is det er mined by t he s. 90 t ax payable f or t he account ing per iod, t he second and subsequent penalt ies ar e Sch 18 FA 1998 r educed so t hat t hey do not exceed t he maximum of such penalt ies.
C8.8 Failure to pay by instalments
I f a company deliber at ely and r ecklessly f ails t o pay it s inst alment s or makes a Par a 13 claim f or r epayment of instalment s, t her e is a penalt y of t wice t he amount of SI 1999/ 3175 int er est char ged on t he t ax unpaid.
160 Principles of Business Taxat ion ‘Finance Act 2006’
SUMMARY – CTSA PENALTY REGIME
Penalt ies will apply where a r et ur n is lat e.
The f lat r at e penalt ies ar e:
£ 100 up t o 3 mont hs lat e; £ 200 more t han 3 mont hs lat e;
Tax gear ed penalt ies ar e char ged if t he r et urn is filed more than 18 months after t he end of t he CAP. The penalt ies ar e:
10% of t ax unpaid at 18 mont hs if r et ur n > 18 mont hs af t er CAP 20% of t ax unpaid at 18 mont hs if r et ur n > 24 mont hs af t er CAP
An init ial penalt y of £ 300 will be char ged wher e a company f ails t o not if y char geabilit y in accor dance wit h s.55 FA 2004. An addit ional penalt y of £ 60 a day can be char ged.
A £ 3,000 penalt y can be char ged wher e incor r ect inf or mat ion is pr ovided negligent ly or f r audulent ly in r elat ion t o not if icat ion of char geabilit y.
Penalt ies will also be applied wher e t her e has been a f ailur e t o keep r ecor ds or t he r et ur n is incor r ect due t o f r audulent or negligent conduct .
C9: INCOME FROM PROPERTY
This chapt er will consider t he t axat ion of income f r om pr oper t y in par t icular : - r ules r elat ing t o Schedule A; - r ever se pr emiums; - r ent f act or ing; - r eal est at e invest ment t r ust s.
C9.1 Introduction
I ncome f r om UK situated property is t axed on companies under Schedule A.
I ncome f r om overseas property is t axed under Schedule D Case V.
Income from all property is t r eat ed as a single sour ce of business income. A single sour ce means t hat all pr of it s and losses are pooled together. Where t he pool cr eat es a pr of it , we t ax it under Schedule A; wher e t he pool cr eat es a loss, we r elieve it under t he Schedule A loss r elief r ules.
We br ing t he income int o char ge t o t ax using account ing pr inciples as applied for Schedule D Case I , ie t he basis of t axat ion will be an accruals basis for the r ecognit ion of income.
Example 1
Rent on Limit ed acquir es an invest ment pr oper t y on 1 J uly 2006 and let s it out immediat ely on an annual r ent of £ 24,000, payable on t he f ir st day of each mont h in advance.
How much r ent al income will be t axable in Rent on Limit ed’s account ing per iod f or t he year ended 31 March 2007?
C9.2 Expenses
As r ent al income is t r eat ed as business income, deduct ion of expenses f ollows t he nor mal r ules. Relief is given f or expenses which have been incur r ed wholly and exclusively for the purposes of the rental business. This is the same as deduct ion f or t r ading expenses as given by Sect ion 74 I CTA 1988.
The det ailed r ules on allowable expenses ar e cover ed wit hin t he I ncome Tax cour se. 162 Principles of Business Taxat ion ‘Finance Act 2006’
Common deduct ible expenses include: (i) Maint enance and r epair s but not impr ovement s - r edecor at ion would t her ef or e qualif y but not anyt hing t o act ually impr ove t he f abric of t he building. For inst ance, a complet e r ef ur bishment when t he pr oper t y is f ir st pur chased would not be an allowable deduct ion against r ent al income. I f a window get s br oken and a new pane is f itted, that is deduct ible as a maint enance or r epair cost . (ii) I nsur ance (iii) Management and agent s f ees (iv) Rent collect ion cost s (v) Adver t ising f or t enant s (vi) 10% wear and t ear allowance - t his is only available f or f ur nished pr oper t y and is calculat ed as 10% x (r ent s less council t ax and wat er r at es).
Example 2
Comlet Limit ed let s a f ur nished pr oper t y on commer cial t er ms. The r ent al income char ged f or t he per iod t o 31 December 2006 was £ 20,000 r ising t o £ 22,000 f or t he period t o 31 December 2007.
Expenses r elat ing t o let t ing included: £ Wat er r at es 1,000 I nsur ance 500 Ground r ent 700
Agent ’s f ees amount ed t o 15% of r ent al income. I n November 2006 t he t enant accident ally damaged t he ceiling in t he living r oom. Comlet Limit ed t ook t he oppor t unit y t o r ef ur bish t he whole r oom at a t ot al cost of £ 4,000. The cost r elat ing t o r ect if ying t he damage amount ed t o only £ 500.
Comlet Limit ed makes up account s f or t he year ended 31 March 2007. What is t he Schedule A income?
C9.3 Loan interest
For companies, interest on a loan taken out to purchase a rental property is not an allowable expense in ar r iving at t he income t axed under Schedule A. I nst ead t he loan int er est is t r eat ed as a non-t r ading loan r elat ionship debit under t he loan r elat ionship r ules. These ar e cover ed in a lat er chapt er .
C9.4 Schedule A losses
The r elief f or Schedule A losses is cover ed lat er in t he chapt er ent it led Relief f or Ot her Losses. I ncome f r om Proper t y 163
C9.5 Reverse premiums
A r ever se pr emium ar ises when a per son r eceives a payment to enter into a lease. For many year s t he t ax t r eat ment of r ever se pr emiums was uncer t ain and of t en depended on t he f act s of t he case.
Rever se pr emiums ar e revenue receipts. Wher e t hey ar e r eceived in connect ion Par a 22 wit h land used f or t he pur pose of a t r ade t hey will be a t r ading r eceipt , Sch 6 FA 1999 ot her wise t hey will be char geable t o Schedule A.
Gener ally t he pr emium will be t axed over t he lif e of t he lease. However t his r ule Par a 3 will not apply if t he lease is bet ween connect ed per sons and not on ar m’s lengt h Sch 6 FA 1999 t er ms in which case t he pr emium will be br ought in as a r evenue r eceipt in t he per iod t hat t he lease is ent er ed int o.
Under Sch 6 t he f ollowing are not cover ed by t he r ules: Par a 5-7 Sch 6 • r eceipt s t aken account of f or capit al allowances; FA 1999 • t r ansact ions r elat ing t o a PPR; • t r ansact ions caught by t he sale and lease back r ules.
A Revenue I nt er pr et at ion t ells us t hat t he aim of Sch 6 is t o t ax payment s or RI Dec 1999 ot her benef it s which ar e inducement s t o ent er leases.
The most common f or m of commercial inducements include: • Rent f r ee per iods; • Cont r ibut ion t o t enant cost s; • Assumpt ion of t he t enant ’s liabilit ies; • Wr it ing of f sums owed.
Sch 6 only char ges t hose inducement s t hat involve t he laying out of money not amount s f or gone or def er r ed.
The f ollowing will not be taxed: • Rent f r ee per iods; • Replacing a lease when mar ket condit ions have changed so as to reduce the r ent ; • Replacing an exist ing lease t o r emove clauses made oner ous by mar ket condit ions.
The Revenue have given guidance in r elat ion t o f it t ing out cost s. I f t he landlor d pays t he t enant ’s f it t ing out cost s t hen t his will be caught . However if t he t enant ef f ect ively r epays t he landlor d in t he f or m of higher rent s t hen t his will not be caught .
164 Principles of Business Taxat ion ‘Finance Act 2006’
The Revenue give t he example of complet ion cost of a building. A t enant want s a special t ype of r oof and agr ees t o be r esponsible f or t he inst allat ion. Reimbur sement by t he landlor d of t he cost of inst alling t he r oof will not be t axable ir r espect ive of whet her t he landlor d r eimbur ses t he cost of a nor mal r oof or a specialist r oof as t o complet e t he building t her e must be a r oof .
C9.6 Real Estate Investment Trusts (REIT) s.103 FA 2006
For account ing per iods beginning on or af t er 1 J anuar y 2007 cer t ain qualif ying companies may, by giving not ice t o HMRC, be t r eat ed as a Real Est at e I nvest ment Tr ust (REI T).
A company which is a REI T will be exempt f r om cor por at ion t ax and capit al gains par a 119 on it s exempt business. FA 2006
I n summar y, t o qualif y t he company must be a UK r esident company list ed on a par a 107 r ecognised st ock exchange t hat is r ent ing out at least t hr ee pr oper t ies. The FA 2006
company must dist r ibut e at least 90% of it s pr of it s bef or e t he f iling dat e f or it s t ax r et ur n. Ther e ar e r ules r est r ict ing t he t ype of shar e capit al and t he maximum shar eholding allowed by any one shar eholder .
When a REI T makes a dist r ibut ion it will not be t r eat ed as a dividend. I nst ead t he shar eholder s will be t r eat ed as r eceiving income f r om pr oper t y. Wher e t he shar eholder is a company t his will be t r eat ed as Schedule A income.
I ncome f r om Proper t y 165
Answer 1
The r ent al income accr ues f or t he per iod 1 J uly 2006 t o 31 March 2007, which is a per iod of nine mont hs.
£ 24,000 x 9/ 12 = £18,000
Answer 2
Y/ e 31.3.07 £ Rent al income accr ued: 9 3 20,500 £ (20,000 x ) + (22,000 x ) 12 12
Expenses: Agent ’s f ees: £ 20,500 x 15% (3,075) Redecor at ion Nil Wat er r at es (1,000) I nsur ance (500) Ground r ent (700) Wear and tear: 10% x (20,500 – 1,000) (1,950)
Schedule A income £13,275
166 Principles of Business Taxat ion ‘Finance Act 2006’
SUMMARY – INCOME FROM PROPERTY
Schedule A income is t axed on an accr uals basis.
Relief is given f or expenses incur r ed wholly and exclusively f or t he Schedule A business.
I nt er est on loans t aken out t o buy pr oper t ies is never a Schedule A expense f or companies, it is inst ead r elieved under t he loan r elat ionship r ules.
Rever se pr emiums ar e t axed as a r evenue r eceipt . The r ules only r elat e t o t he laying out of cash.
From 1.1.07 companies can, by giving notice, to be treated as a REIT. A REIT is exempt f r om cor por at ion t ax and capit al gains t ax. Shar eholder s r eceiving dist r ibut ions will be t r eat ed as r eceiving pr oper t y income.
C10: LOAN RELATIONSHIPS
This chapt er looks at loan r elat ionships cover ing in par t icular : - t he meaning of loan r elat ionship; - t r ade v non t r ade; - relief f or non t rade def icit s; - connect ed par t ies; - bad debt relief ; - special r ules f or gr oups.
C10.1 Definition s.81 FA 1996
A loan r elat ionship is any transaction involving t he borrowing or lending of money. For a loan r elat ionship t o exist t her e must be a t r ansact ion f or t he lending of money.
This will include interest received on bank accounts, int er est r eceived on loan stock or debent ur es or even int er est paid t o t he company by t he gover nment on a t ax r epayment .
The loan r elat ionship r ules also cover interest paid by a company – f or example; int er est on a bank overdraft, debent ur e int er est paid t o loan st ockholder s or interest on a loan t aken out by t he company t o buy a new building or t o pur chase t r ading st ock.
We can conclude f r om t he above t hat what we need is a money debt t hat has s. 81(1) arisen f rom t he lending of money. Thus if a company was t o sell some shares but FA 1996
did not immediat ely r eceive t he cash, we do not necessar ily have a money debt . s.81(6) Ther e is a debt - however , it ar ises f r om t he selling of t he shar es and not f r om FA 1996 t he lending of money. Money debt s include non-sterling cur r ency.
Wher e an inst r ument is dr awn up t o evidence t he money debt , t here will be a s. 81(3) t r ansact ion f or t he lending of money. FA 1996
Debt s ar ising in r elat ion t o shar es in t he company (f or example, non-payment of s. 81(4) dividends) do not give r ise t o loan r elat ionships. FA 1996
168 Principles of Business Taxat ion ‘Finance Act 2006’
Example 1
Which of t he f ollowing const it ut e a loan r elat ionship? a) Debent ur es in a company b) Gover nment gilt s c) Bank deposit account d) Bank over dr af t e) Debt or s ledger f) Loan t o an employee
C10.2 Debits and credits s.84 –s.85 FA 1996
Debit s and cr edit s on loan r elat ionships f ollow t he account ing t r eat ment , i.e. t he pr of it and loss account def init ion, in t hat debits are expenses and credits are income. The rule int roduced in Finance Act 1996 is t hat t he amounts put through the profit and loss account or income st at ement in accor dance wit h UK gener ally accept ed account ing pr act ice or int er nat ional account ing st andar ds, ar e t he amount s t hat ar e t ax deduct ible (if expenses) or t hat ar e t axable (if income). This includes amount s r ecognised: • in t he company’s st at ement of r ecognised gains and losses or st at ement of changes in equit y, or • in any ot her st at ement of it ems br ought int o account in comput ing t he company’s pr of it s and losses f or t hat per iod.
The amount s put t hr ough t he pr of it and loss account and ot her st at ement s f or account ing pur poses ar e int er est receivable and int er est payable. I t includes pr ior year adj ust ment s but not t he cor r ect ions of f undament al er r or s.
I n t he case of a f undament al er r or t he company should amend t he r et ur n f or t he ear lier per iod.
I t is not j ust int er est t hat comes wit hin t he loan r elat ionship r ules. All debits and credits in relation to the debt liability ar e t axed under t he r ules.
Example 2
Which of t he f ollowing are eligible f or t ax r elief under t he loan r elat ionship r ules? a) I nt er est payable b) Ear ly r edempt ion penalt ies c) Bank ar r angement f ees d) Amount s wr it t en of f loans (bad debt s) e) Loss on disposal of loan st ock Loan Relat ionships 169
C10.3 Trading v non-trading s.82 FA 1996
A company can be eit her a debt or or a cr edit or in t er ms of a loan r elat ionship. I n eit her case t he t ax t r eat ment is det er mined by looking at whet her t he loan r elat ionship is trade or non-trade.
Looking at t he posit ion wher e t he company is t he bor r ower , we ask “why did t he company bor r ow t he money”?
A trading purpose is def ined as a loan t aken out f or t he pur poses of t he t r ade. Gener ally speaking, t his is wher e t he funds are used to generate income which is taxed under Schedule DI. An example could be a loan t o buy st ock used in t he t r ade.
The loan equally may have been ent er ed int o f or a non-trading purpose. This is wher e t he funds are used to generate income which is not taxed under DI. A good example of t his could be a loan t aken out t o buy unit s in a unit t r ust , which gener at es invest ment income r at her t han t r ading income.
Example 3
Classif y t he f ollowing loans bet ween t r ading and non-t r ading: a) Loan t o buy a f act or y b) Loan t o buy r ent al pr emises c) Loan t o buy shar es on t he st ock mar ket d) Loan t o buy shar es in a t r ading subsidiar y company e) Funds lent t o a subsidiar y f or t he pur pose of it s t r ade.
When we look at loans wher e t he company is t he cr edit or , we def ine t r ade and non-t rade slight ly dif f erent ly. This t ime we ask was t he lending of t he money done as an int egr al par t of t he company’s t r ade? Her e t he answer will only be “yes” in t he case of banks and f inancial inst it ut ions.
C10.4 Tax treatment This can best be summar ised by a f lowchar t :
170 Principles of Business Taxat ion ‘Finance Act 2006’
Pur pose of t he loan?
Tr ading Non t r ading
Debit Credit Debit Credit
Pool DI expense DI income
NET NET DEBI T CREDI T
DI I I loss DI I I income or def icit C10.5 DIII loss relief
The rules f or relief f or Schedule D Case I I I def icit s (or “DI I I losses”) ar e ver y s. 83(2) similar t o t he r ules r elat ing t o Schedule D Case I losses, which will be cover ed in FA 1996 a lat er chapt er .
Illustration 1
Assume a company t akes out a loan of £ 100,000 t o buy a por t f olio of quot ed shar es. I nt er est payable on t he loan is £ 10,000 per annum.
This is quit e clear ly a non-t r ade loan as t he income gener at ed by t he quot ed shar es will be dividend income which is not t axed under Schedule DI .
Assume t he company has a bank deposit account which ear ns int er est of £ 6,000 per annum. This int er est is t axable under Schedule DI I I .
I nt er est payable on non-t r ading loans is deduct ed f r om DI I I income as f ollows;
Schedule DIII credits 6,000 Schedule DI I I debit s (10,000) DI I I loss £ (4,000)
Loan Relat ionships 171
The next st ep t o consider is what t he company can do wit h t his DI I I loss?
1. Relief is allowed in t he current year against other income bef or e char ges s.83(2)(a) including capit al gains. This is given in pr ior it y t o Schedule D Case I cur r ent FA 1996 year loss r elief . Ther ef or e if a company makes DI I I and DI losses in t he same year , and makes t wo separ at e cur r ent year claims, t he DI I I loss claim will be relieved f irst ; or
2. Ther e is a car r y back pr ovision, wher eby t he Schedule DI I I loss can be s.83(2)(c) carried back one year and set against DIII income in t he pr evious FA1996 account ing per iod. This is DI I I as r educed by any char ges on income or ot her losses, in t he pr evious year ’s comput ation. This is t he only claim which is det er mined by a set f or mula and is not ent ir ely open t o t he company t o decide; or
s.403 3. DI I I def icits are available f or group relief by allowing t he loss t o be I CTA 1988 t r ansf er r ed t o a f ellow 75% gr oup company. These r ules will be cover ed in det ail in a lat er chapt er ; or
s.83(3A) 4. Carry forward t he DI I I loss, and set it against future non-trading profits. FA1996 This is basically any income and gains in t he f ut ur e year , except DI .
I t should be appr eciat ed t hat all of t hese claims ar e independent and we can make a cur r ent year claim bef or e we car r y back or a gr oup r elief claim whenever we want t o, et c.
What we gener ally must r emember is t he two key rules f or r elieving losses:
(i) set t hem of f against t he income subj ect t o t ax at t he highest marginal rate; and (ii) t r y t o r elieve t hem earlier rather than later.
In the claim, we must specify the amount that we wish to relieve and t her ef or e, it does gives us f lexibilit y t o use par t of t he loss in say, t he cur r ent year , and par t of it by say gr oup r elief , if t hat is what we want t o do.
To the extent that the DI I I def icit is not used by gr oup r elief , cur r ent year claim or carry back it will go f orward t o be used against non-t r ading pr of it of t he Par a 4 succeeding account ing per iod. The company will have two years to make a claim Sch 8 not to have the deficit set off against non-trading profit in t he succeeding FA 1996 account ing per iod.
172 Principles of Business Taxat ion ‘Finance Act 2006’
Example 4
Which of t he f ollowing is not available t o r elieve a Schedule D Case I I I def icit ? a) Set of f against gener al income in t he cur r ent year b) Set of f against gener al income in t he pr eceding 12 mont hs c) Group r elief d) Car r y f or war d against non-t r ading pr of it s in f ut ur e per iods
C10.6 Connected parties s.87 & 87A FA 1996 Wher e t he par t ies ar e connect ed, t he only accounting basis t hat can be used is the amortised cost basis.
C10.7 Late interest Par a 2 Sch 9 FA 1996 Wher e t he par t ies t o a loan r elat ionship ar e connected and t he int er est is not paid within 12 months of the end of the accounting period, a debit f or that int er est will not be allowed unt il it has been paid if t he credit or is not wit hin t he char ge t o cor por at ion t ax in r espect of t he loan - f or example wher e t he cr edit or is t he over seas par ent of t he debt or .
Example 5
When is int er est deduct ible on a paid basis? a) I f t he int er est r emains unpaid 12 mont hs af t er t he year end; or b) Wher e t he bor r ower and lender ar e connect ed; or c) Wher e t he lender is not char geable t o cor por at ion t ax; or d) Wher e all of t he above apply.
C10.8 Bad debt relief – impairment losses
Bad debt s ar e r ecor ded in a company’s account s as “impair ment losses”. Tax r elief is obt ained f or such impair ment losses simply by t he t ax t reat ment f ollowing t he account ing t r eat ment .
Wher e companies ar e connect ed at any t ime in an account ing per iod, t he cr edit or company cannot br ing in debit s r elat ing t o amount s writ t en of f a loan r elat ionship.
The ar e t wo except ions t o t his r ule f or connect ed par t y loans:
i. When t her e is a f or giveness of debt f or equit y and no connect ion exist ed bef or e t he equit y was issued. I n which case a debit is allowed in t he account ing per iod of t he issue only and only in r elat ion t o t he debt equit y swap.
ii. When t he cr edit or is in insolvent liquidat ion Loan Relat ionships 173
C10.9 Impairment and cessation of connection Par a 6c Sch 9 FA 1996
A connect ion bet ween companies may cease whilst a debt is st ill in exist ence f or example if t he debt or company is sold out of t he gr oup.
The cr edit or company cannot br ing in any debit s t hat r elat e t o ear lier wr it e- Par a 6c Sch 9 downs in t he account s t hat wer e not r elieved because of Par a 6 Sch 9 FA 1996. FA 1996
A company does not have t oo br ing a cr edit int o account f or r ever sal of an Para 6 (3A) impair ment loss t hat has been disallowed because t he companies ar e connect ed. Sch 9 FA 1996
C10.10 Impairment losses and consortium relief Par a 5A Sch 9 FA 1996 Wher e t her e is a consor t ium t he companies will not always be connect ed f or t he pur poses of loan r elat ionships.
As a r esult r elief f or impair ment losses will be available t o consor t ium member s.
I f r elief has been allowed f or impair ment losses t o a consor t ium member or gr oup member via a link company, t hen t her e will be a r est r ict ion on t he consor t ium r elief t hat can be claimed.
The amount of consor t ium r elief t hat can be claimed is r educed by t he debit s alr eady allowed in ear lier account ing per iods f or impair ment against t he loan. Illustration 2 M Lt d holds 30% of CC Lt d. M Lt d has made a loan of £ 1,000,000 t o CC Lt d. CC Lt d has been exper iencing pr oblems f or many year s and t o dat e £ 250,000 of t he loan has been wr it t en of f .
I n t he period t o 31 March 2007, M Lt d makes a consor t ium r elief claim f or losses of £ 300,000 f r om CC Lt d. The losses under t he consor t ium claim will be r educed t o £ 50,000 t o t ake account of t he bad debt r elief pr eviously given.
C10.11 Loans for an unallowable purpose
No debit s will be allowed unless t he loan is f or an allowable pur pose.
Two classes of unallowable pur pose ar e set out in t he legislat ion:
(i) t he loan is in r elat ion t o any par t of t he company’s activities which are not within the charge to corporation tax; or (ii) t he main pur pose of t he loan is tax avoidance.
Tax avoidance is def ined as secur ing a t ax advant age. This is a ver y wide def init ion as set down by s.703 I CTA 1988.
174 Principles of Business Taxat ion ‘Finance Act 2006’
C10.12 Money debts etc not arising from the lending of money s.100 FA 1996
Wher e t her e is a money debt which ar ises f r om a t r ansact ion which is not f or t he lending of money and t he money debt is one:
i. on which int er est is payable t o or by t he company; or
ii. in r elat ion t o which exchange gains or losses ar ise t o t he company; or
iii. in r espect of which a payment would f all t o be br ought int o account f or t he pur poses of cor por at ion t ax as a r eceipt of a t r ade, Schedule A business or over seas pr oper t y business and in r elat ion t o which an impair ment loss (or r ever sal) ar ises t o t he company; or
iv. wher e a discount ar ises
there is deemed to be a loan relationship, but t he only debit s or credit s t o be br ought in ar e t hose r elat ing t o t he mat t er s st at ed above.
S.100 also pr ovides t hat int er est payable/ r eceivable under t he Taxes Act ar e t o be t r eat ed as non t r ading debit s or cr edit s.
As a r esult of t he amendment s t o s.100 we will now see pr ovisions against t r ade debt or s being r elieved under t he loan r elat ionship r ules. Remember t hat under I AS no gener al pr ovisions will be allowed - all pr ovisions will be specif ic.
Loan Relat ionships 175
Answer 1
All but the debtors ledger (e) – t his is not a loan r elat ionship as it has not ar isen t hr ough t he lending of money but t hr ough t he company selling goods or pr oviding ser vices t o a cust omer .
Answer 2
All items are tax deductible as t hey ar e all amount s put t hr ough t he account s r elat ing t o a loan.
Answer 3
(a) The loan t aken out t o buy t he f act or y is a trading loan, pr oviding t he f act or y is used by t he company f or t he pur pose of it s t r ade.
(b) The loan t aken out t o buy r ent ed premises gener at es Schedule A income, t her ef or e, as t his is not DI , it is a non-trading loan.
(c) The loan t aken out t o buy shar es on t he st ock mar ket pr oduces dividend income, again t his is not DI , so is a non-trading loan.
(d) Equally t he loan t aken out t o buy shar es in t he t r ading subsidiar y, is also a non-trading loan because, again t hese shar es will gener at e dividend income. I t doesn’t mat t er what t he subsidiar y act ually does, what is impor t ant is t hat we ar e buying shar es and shar es do not gener at e t r ading income (unless t he company is a shar e dealing company).
(e) The loan t aken out t o lend money t o a subsidiar y f or t he pur poses of it s t r ade is again a non-trading loan, because t he loan is not t aken out t o f und t he t r ade of t he lending company. This of cour se is on t he assumpt ion t hat t he lending company is not a bank.
Answer 4
The answer is (b)
The set of f is against DI I I income (not gener al income) of t he pr eceding 12 mont hs.
Answer 5
The answer is (d)
176 Principles of Business Taxat ion ‘Finance Act 2006’
SUMMARY – LOAN RELATIONSHIPS
A loan r elat ionship ar ises when t her e is t he lending of money.
I nt er est payable on t r ading loans is deduct ed f r om DI income.
I nt er est payable on non t r ading loans (e.g. int er est on a loan t o buy an invest ment pr oper t y) is deduct ed f r om DI I I income.
I nt er est r eceivable will be t reat ed as DI I I in most cases.
DI I I debit s and credit s are pooled if t he DI I I debits exceed the DI I I credits then loss r elief is available f or t he r esult ing def icit .
A DI I I def icit can be set of f against other income in t he cur r ent year , gr oup r elieved, car r ied back or car r ied f or war d.
Special r ules apply f or connect ed par t ies. They must use t he amor t ised cost basis of account ing. Bad debt r elief will not usually be available and int er est unpaid mor e t han t welve mont hs af t er t he year end will not be allowed a deduct ion if t he r ecipient is not char geable t o UK t ax.
I mpair ment of t r ade debt or s has been br ought wit hin t he loan r elat ionship r ules as have all money debt s wit h discount s.
Ther e ar e ant i-avoidance r ules t o deal wit h loans f or unallowable pur poses.
C11: RELIEF FOR TRADING LOSSES
This chapt er examines t he r elief available t o a company when it makes a t r ading loss in par t icular : - the availability of relief f or trading losses in t he cur r ent and ear lier account ing per iods; - the effect of carrying forward the t r ading loss t o a lat er per iod.
C11.1 Introduction
A company makes a loss when it s income is less t han it s expenses. The loss per t he account s is adj ust ed f or t he nor mal t ax deduct ions, such as disallowed expendit ur e (e.g. ent er t aining, depr eciat ion) and can be incr eased by claiming capit al allowances. A company may not wish t o claim all of t he capit al allowances in or der t o r educe t he amount of loss.
Wher e t he adj ust ed Schedule D Case I f igur e is a loss, t he Schedule D Case I assessment in t he cor por at ion t ax comput at ion will be nil. The loss it self is r elieved by making a number of separ at e claims.
C11.2 Relief for trading losses
Ther e ar e a number of opt ions available: s.393A(1)(a) (i) Set against t ot al pr of it s bef or e char ges in t he cur r ent account ing per iod. I CTA 1988
s.393A(1)(b) (ii) Carry back and set against total profits before non-trade charges in I CTA 1988 t he pr eceding 12 months.
s.393(1) (iii) Carry forward and set against next available future profits from the I CTA 1988 same trade.
(iv) Surrender t he loss to a fellow 75% owned group company. This t ype of s.402 r elief is known as gr oup r elief . These r ules will be cover ed in a lat er I CTA 1988 chapt er .
C11.3 Current year relief
The loss is set against t ot al profits before charges of t he cur r ent year .
The claim must be f or t he lower of t he available loss or t he available pr of it . s. 393A(1)(a) I n ot her wor ds, no par t ial claims ar e allowed, t he claim must eit her use all of t he loss, or eliminat e all of t he available pr of it s. 178 Principles of Business Taxat ion ‘Finance Act 2006’
Illustration 1
Lossingt on Lt d has t he f ollowing r esult s f or t he year t o 31 March 2007:
£ Trading loss (70,000) Char geable gains 15,000 Schedule A 21,000 Charge on income (3,000)
The cur r ent year claim under s.393A(1)(a) will be as f ollows:
12m t o 31.3.07
£ Schedule DI Nil Schedule A 21,000 Char geable gains 15,000 Tot al prof it s 36,000 s.393A(1)(a) Cur r ent year loss (36,000) - Char ge on income Unr elieved PCTCT -
As t he loss is of f set bef or e t he deduction f or char ges on income, t he char ge her e is unr elieved.
The unr elieved t r ading loss of £ 34,000 will be car r ied f or war d against f ut ur e pr of it s f r om t he same t r ade.
This is summar ised in a loss memor andum as f ollows:
Loss memor andum £ Loss (y/ e 31.3.07) 70,000 Current year claim s.393A(1)(a) (36,000) Unr elieved loss t o car r y f or war d £ 34,000
C11.4 Unrelieved charges
Unr elieved trade charges may be car r ied f or war d and set against f ut ur e pr of it s of t he same t r ade i.e. t hey ar e added to the s.393(1) loss car r y f or war d.
However , f ollowing t he int r oduct ion of t he IFA rules wit h ef f ect f rom 1 April 2002, t r ade char ges became ver y r ar e, and, looking f or war d, t r ade char ges no longer exist . Ther ef or e, it makes sense t o ignor e t hem f or t he r est of t his session.
Relief f or Trading Losses 179
Non-trade charges, such as Gif t Aid payment s, ar e lost if there is no prof it in t he cur r ent year t o set t hem against . They cannot be car r ied f or war d.
C11.5 Carry back of losses
The claim t o carry back a loss under s.393A(1)(b) may only be made once a s. 393A(1)(b) current year claim has been made, under s.393A(1)(a) – i.e. (a) bef or e (b).
The loss car r ied back is set against pr of it s in t he previous 12 months, bef or e any non-t r ade char ges.
As wit h t he current year claim, t he carry back claim must be f or t he lower of t he available loss or t he available pr of it .
Illustration 2
Assume in t he last illust r at ion t hat Lossingt on Limit ed had t he f ollowing income in t he pr evious 12 mont h account ing period, t he year ended 31 March 2006:
£ Schedule D Case I 10,000 Schedule A 21,000 Gift Aid payment (1,000)
As a cur r ent year claim t o use t he loss in t he year ended 31 March 2007 has alr eady been made, we can now car r y t he loss back t o t he year ended 31 Mar ch 2006.
The carry back claim under s.393A(1)(b) will be 12m t o 31.3.06
£
Schedule D Case I 10,000 Schedule A 21,000 Tot al 31,000 Cur r ent year loss (nil as t here is no loss in t his year ) - _____ 31,000 s.393A(1)b Losses car r ied back (31,000) Nil Non-t r ade char ges (Gif t Aid) Unr elieved PCTCT Nil
180 Principles of Business Taxat ion ‘Finance Act 2006’
This f ur t her use of t he loss can again be shown in t he loss memor andum as f ollows:
Loss Memo: £ Tot al loss 70,000 Cur r ent year claim (f r om I llust r at ion 1) (36,000) 34,000 Carry back claim s.393A(1)(b) (31,000) Loss t o car r y f or war d £ 3,000
I f a company wishes t o make a claim under s. 393(A) t o use it s losses in t he cur r ent year / pr eceding year , it must notify the Revenue within two years of t he end of t he account ing per iod in which t he loss was made.
I n t his example a claim must be made no lat er t han 31 Mar ch 2009. The Revenue may ext end t his t ime limit at t heir discret ion.
C11.6 Losses carried forward
The losses ar e set against t he f ir st available f ut ur e pr of it s f r om t he same s. 393(1) t r ade under s.393(1) i.e. against DI income only.
No claim is r equir ed as t he r elief is given automatically. The r elief is compulsor y - if we have a loss br ought f or war d, it will aut omat ically be set against t he next available f ut ur e pr of it s f r om t he same t r ade.
Illustration 3
I n t he Lossingt on Limit ed illust r at ion t her e is an unr elieved loss of £ 3,000.
Assume t he company has t he f ollowing r esult s in t he year ended 31 March 2008:
Schedule D Case I £15,000 Schedule A £21,000
The r elief available under s.393(1) will be as f ollows: £ Schedule D Case I 15,000 s.393(1) loss br ought f or war d (3,000) 12,000 Schedule A 21,000 PCTCT £ 33,000
Finally her e let ’s show t he comput at ions of PCTCT f or all t hr ee year s her e in columns next t o each ot her , as you would pr obably set it out like t his in an examinat ion quest ion: Relief f or Trading Losses 181
Year ended 31 Mar ch 2006 2007 2008 £ £ £ Schedule D Case I 10,000 nil 15,000 Less losses b/ f wd - - (3,000) 10,000 nil 12,000 Schedule A 21,000 21,000 21,000 Char geable gains - 15,000 - 31,000 36,000 33,000 Less cur r ent year loss ______(36,000) _____ 31,000 nil 33,000 Less car r ied back loss (31,000) ______nil nil 33,000 Less non t r ade char ges Lost Lost - PCTCT nil nil 33,000
Example 1
X plc has t he f ollowing r esult s: Y/ e 31.3.06 Y/ e 31.3.07 Y/ e 31.3.08 £ £ £ Schedule DI profit 100,000 nil 14,000 Trading loss (150,000) Schedule DIII 10,000 12,000 5,000 Char geable gain 12,000 - - Non trade charge (500) (500) (500)
You ar e r equir ed t o: (a) Show how t he t r ading loss will be r elieved assuming r elief is r equir ed as ear ly as possible
(b) List any amount s t o be car r ied f or war d, indicat ing t he r elief available (c) Calculat e t he r epayment of t ax due t o X plc as a r esult of t he loss r elief .
C11.7 Carry back complications
Remember that the carry back of a loss is for a full 12 month period. If the previous accounting period is less than 12 months, you can carry back to the per iod bef or e t hat one by applying time apportionment to the profits before charges of the previous period.
182 Principles of Business Taxat ion ‘Finance Act 2006’
Example 2
Losst er Limit ed has t he f ollowing r esult s in r ecent year s: Y/ e 6m/ e Y/ e Y/ e 30.9.05 31.3.06 31.3.07 31.3.08 £ £ £ £ Schedule D Case I 26,000 12,000 nil 6,000 Trading loss (50,000) Schedule A 10,000 5,000 10,000 10,000 Non-trade charges (1,000) (1,000) (1,000) (1,000) (a) What will t he S. 393A(1)(a) claim be? (b) What will t he S. 393A(1)(b) claim be? (c) How much loss will be r elieved under S. 393(1)?
Relief f or Trading Losses 183
Answer 1
(a) X plc
Year ended 31 Mar ch 2006 2007 2008 £ £ £ Schedule D Case I 100,000 nil 14,000 Less losses b/ f wd - - (14,000) 100,000 nil nil Schedule DIII 10,000 12,000 5,000 Char geable gains 12,000 - - 122,000 12,000 5,000 Less cur r ent year loss ______(12,000) _____ 122,000 nil 5,000 Less car r ied back loss (122,000) ______nil nil 5,000 Less non t r ade char ges Lost Lost (500) PCTCT Nil Nil 4,500
(b) Loss Memo:
£ Loss y/ e 31.3.07 150,000 Used cur r ent year 31.3.07 (12,000) Used pr evious year 31.3.06 (122,000) Available t o car r y f or war d 16,000 Used f ollowing year 31.3.08 (14,000) Loss available t o c/ f wd 2,000
(c) Tax repayment y/ e 31 March 2006
Or iginal comput at ion:
£ DI pr of it 100,000 DI I I 10,000 Gain 12,000 122,000 Less: non t r ade char ge (500) PCTCT 121,500
GCT @ 19% £ 23,085
The whole of t he t ax of £ 23,085 will be repaid as PCTCT is r educed t o nil af t er t he car r y back of losses.
184 Principles of Business Taxat ion ‘Finance Act 2006’
Answer 2
(a) Cur r ent Year Claim
Y/ e 31.3.07 £ Schedule D Case I Nil Schedule A 10,000 Tot al Prof it s 10,000 s.393A(1)(a) current year loss (10,000) Nil Non-t r ade char ges Unr elieved PCTCT Nil
Loss Memo:
£ Tot al loss 50,000 Current year claim (10,000) £40,000
The unr elieved non t r ade char ges will be lost .
(b) Losses Car r ied Back
Y/ e 30.9.05 6m/ e 31.3.06 £ £ Schedule D Case I 26,000 12,000 Schedule A 10,000 5,000 36,000 17,000 s.393A(1)(b) loss brought back (18,000)* (17,000) 18,000 Nil Non-t r ade char ges (1,000) Unr elieved PCTCT £ 17,000 Nil
* The t ime appor t ioned car r y back is calculat ed on pr of it s bef or e char ges 6 i.e. £ 36,000 x = £ 18,000. 12
Relief f or Trading Losses 185
(c) Loss Car r ied For war d
Y/ e 31.3.08 £ Schedule D Case I 6,000 Losses brought forward (5,000) 1,000 Schedule A 10,000 11,000 Non-t r ade char ges (1,000) PCTCT £10,000
Loss memo: £ Tot al loss 50,000 Current year (10,000) Carried back to 6m/e 31.3.06 (17,000) to 12m/e 30.9.05 6 £ 36,000 x (18,000) 12
Carried forward 5,000 Of f set in y/ e 31.3.08 (5,000) Carried forward Nil
186 Principles of Business Taxat ion ‘Finance Act 2006’
SUMMARY – RELIEF FOR TRADING LOSSES
When a company makes a t r ading loss it can r elieve it against t he pr of it s of :
(i) t he same account ing per iod, t hen
(ii) t he pr evious 12 mont hs, and any unused loss is t hen aut omat ically
(iii) c/ f wd against f ut ur e t r ading pr of it s only.
A car r y back claim can only be made aft er a cur r ent year claim has been made.
Bot h claims ar e all-or -not hing – par t ial claims ar e not per mit t ed.
The t ime limit f or t hese claims is t wo year s f r om t he end of t he loss making account ing per iod.
Car e needs t o be t aken if t her e is a shor t account ing per iod, as t he car r y back must be against 12 mont hs wor t h of pr of it s, if t he loss is lar ge enough.
When a loss is carried back it will generat e a r epayment of CT paid f or t he ear lier account ing per iod.
C12: RELIEF FOR OTHER LOSSES
This chapt er examines t he r elief available t o a company when it makes ot her losses, cover ing in par t icular : - Schedule A losses; - Management expenses; - Capit al losses; - Ter minal loss r elief ; - Schedule DI I I losses; - Schedule DVI losses on I FAs.
C12.1 Other losses
Ot her losses include: (i) Schedule A losses, on pr oper t y income; (ii) Excess management expenses, f or companies wit h invest ment business; (iii) Capit al losses. (iv) Schedule D Case I I I losses, being def icit s on non t r ading loan r elat ionships; (v) DVI losses on I FAs
C12.2 Schedule A losses
A company may r ent out a number of dif f er ent pr oper t ies, some may make a pr of it , some a loss. All of t he results of each property are pooled together int o a Schedule A pool, ver y similar t o t he r ules f or pooling debit s and cr edit s f or loan r elat ionships.
Wher e t he pool pr oduces a net pr of it , t his is simply t axed under Schedule A as income. Wher e t he pool pr oduces a net loss, r elief will be available.
I nitially Schedule A losses must be set against other profits in the current s.392A I CTA 1988 accounting period. No claim is r equir ed as t he r elief is aut omat ic. The set of f is compulsor y and when we make a Schedule A loss, we simply include a negat ive f igur e in t he cor por at ion t ax comput at ion.
The relief is given in priority t o any DI losses of that year. The excess Schedule A loss, i.e. t he amount of t he Schedule A loss t hat exceeds pr of it s t he cur r ent year , will be available for group relief by sur r ender ing it t o f ellow 75% gr oup companies. A claim is r equired under S. 402 I CTA 1988.
188 Principles of Business Taxat ion ‘Finance Act 2006’
I f gr oup r elief does not r elieve t he r est of t he loss or is not available, t he loss is automatically carried forward and t r eat ed as a Schedule A loss of t he next per iod and t hus it is possible t o set it against ot her pr of it s in t hat f ut ur e per iod.
Losses on over seas pr oper t ies (Schedule DV Losses) ar e pooled t oget her wit h pr of it s on over seas pr oper t ies. Any r esult ing loss is t hen car r ied f or war d and set against Schedule DV pr of it s of f ut ur e account ing per iods. s.392B Ther e is no “mixing and mat ching” of DV losses wit h Schedule A pr of it s.
Remember t hat a Schedule A loss is aut omat ically set against cur r ent year income (which could include income t axed under DV).
C12.3 Management expenses
Management expenses ar e set against investment income and gains in t he current account ing period. This r elief , like t hat f or Schedule A losses, is aut omat ic and compulsor y.
To t he ext ent t hat t he management expenses exceed cur r ent year income and gains, t hey ar e “excess”. Like Schedule A, t hey may be group relieved or , f ailing t hat , t hey ar e carried forward against future income and gains of any descr ipt ion.
C12.4 Capital losses
Capital losses may only be carried forward against future capital gains. Ther e is no cur r ent year r elief against income, t her e is no car r y back and no gr oup r elief . However , gr oup companies can make not ional t r ansf er s t o ensur e gains and losses in dif f er ent gr oup companies ar e set of f against each ot her . This is cover ed in mor e det ail in a lat er chapt er .
C12.5 Terminal loss relief s.393A(7)
When a company ceases t o t r ade, and it makes a loss in t he f inal per iod, it is not possible t o car r y t he loss f or war d, as t her e will be no f ut ur e pr of it s (and no f ut ur e t r ade).
I n t his sit uat ion, t he loss of t he f inal 12 mont hs of t rade can be carried back against t he pr of it s of t he pr evious 3 year s. This ef f ect ively ext ends t he claim under s393A(1) beyond t he nor mal 12 mont h car r y back.
Losses ar e r elieved f ir st against any pr of its of t he f inal per iod (bef or e char ges), t hen ar e car r ied back f or a maximum of 36 mont hs against lat er per iods bef or e t hose of ear lier per iods. Relief f or Ot her Losses 189
C12.6 Schedule DIII losses s.83 FA 1996
I nt er est paid and int er est r eceived on non-t r ading loan r elat ionships is pooled t oget her t o give a Schedule DI I I cr edit (“prof it”) or a Schedule DI I I def icit (“loss”).
The possible claims a company can make t o use a DI I I loss ar e: (i) Set against any pr of it s of t he same account ing per iod; or (ii) Set against DI I I pr of it s of t he pr evious 12 mont hs; or (iii) Sur r ender t o a company in t he same gr oup (“gr oup r elief ”).
DI I I losses ar e ver y f lexible – i.e., t he company can car r y back t he loss wit hout f ir st having t o use t he loss in t he cur r ent year .
DI I I losses ar e used in pr ior it y t o DI t r ading losses and Schedule A losses:
£ I ncome f or per iod X Less DIII deficit (X) Less Schedule A loss (X) Less t r ading losses (X) PCTCT X
To the extent that a DI I I def icit has not been used by gr oup r elief , a cur r ent s.83(3A) year claim or a carry back claim, it will go f or war d t o t he succeeding account ing Par a 4 Sch 8 per iod t o be set against non DI income and gains. I f t he company does not want FA 1996 t his aut omat ic set of f in t he next account ing per iod t hen t hey have t wo year s t o make a claim so t hat all or par t of t he def icit car r ied f or war d is not so set of f .
C12.7 The carry back of a DIII deficit
The carry back claim is an all or not hing claim as it has t o be made f or t he lower Par a 3 of : Sch 8 FA 1996 (i) t he DI I I def icit available f or carry back and (ii) t he pr of it s available t o set it of f against .
The DI I I def icit available t o carry back is the def icit of the current year to the ext ent t hat it has not been r elieved by a cur r ent year or gr oup r elief claim.
C12.8 DVI losses on IFAs Para 35 Sch 29 FA 2002 Wher e a company incur s a non-t r ading loss on I FAs, it has t wo year s f r om t he end of t he account ing per iod of t he loss t o make a claim t o set t he whole or par t of t he loss against t ot al pr of it s of t hat per iod. Alt er nat ively excess DVI losses can be gr oup r elieved.
190 Principles of Business Taxat ion ‘Finance Act 2006’
Ot her wise t he loss is car r ied f or war d and t r eat ed as a non-t r ading debit ar ising in t he next account ing per iod.
C12.9 Losses summary Schedule A losses/ Management DI trading losses DIII deficits Expenses/DVI losses on non trade IFAs
Prof it s bef or e Prof it s bef or e CURRENT Prof it s bef or e Char ges Char ges YEAR Char ges (in priorit y t o bot h (compulsor y of f set f or DI and Sch A losses) Sch A and management expenses)
12 mont hs – against 12 mont hs – against CARRY pr of it s bef or e non- DI I I only N/A BACK t r ade char ges (no need t o cur r ent (must do cur r ent year claim f irst ) year claim f irst ) Any f ut ur e pr of it s Fut ur e pr of it s of CARRY except DI same t r ade Any pr of it s FORWARD (can claim f or t his (aut omat ic) not t o occur ) Excess amount only GROUP Whole loss Whole deficit (i.e. must use in CY RELIEF bef or e gr oup r elieve)
Relief f or Ot her Losses 191
SUMMARY – RELIEF FOR OTHER LOSSES
Schedule A losses must be set -of f against any pr of it s of t he cur r ent per iod. I f excess losses r emain t hese can be car r ied f or war d against f ut ur e pr of it s. Excess Schedule A losses can be also be gr oup r elieved.
Management expenses f or an invest ment company must be set -of f against any pr of it s of t he cur r ent per iod. I f excess management expenses r emain t hese can be car r ied f or war d against f ut ur e pr of it s. Excess management expenses can be also be gr oup r elieved.
Capit al losses can only be used t o r elieve capit al gains of t he same or lat er account ing per iods.
Wher e t he company ceases t o t r ade, t he t r ading loss of t he last 12 mont hs can be car r ied back against pr of it s bef or e non t rade char ges of t he last 36 mont hs r at her t han t he nor mal 12 mont hs.
Schedule DI I I losses can also be of f set against any pr of it s in t he per iod, alt hough a 12 mont h car r y back against DI I I income is also possible. They can also be gr oup r elieved. These claims can be done in any or der and ar e ver y f lexible. Unused DI I I losses ar e aut omat ically car r ied f or war d against f ut ur e non t r ading income and gains unless t he company elect s f or t hem not t o be of f set in t his way.
DVI losses on I FAs can be used in t he cur r ent per iod against ot her income, gr oup r elieved (if excess) or car r ied f or war d.
C13: CORPORATE CAPITAL GAINS
This chapt er explains how companies pay cor por at ion t ax on capit al gains cover ing in par t icular : - how we calculat e t he gain char geable; - what r elief is available against a capit al gain.
C13.1 Introduction
A company pays corporation tax on capital gains ar ising on t he disposal of char geable asset s. Most capit al asset s ar e char geable wit h a number of minor except ions, e.g. car s. The def init ion of a car does not ext end t o vans and ot her commer cial vehicles which may give r ise t o char geable gains wher e t hey ar e sold at a pr of it .
Individuals pay capital gains tax (CGT) on disposals, wher eas companies pay cor por at ion t ax. The r ules f or comput ing gains f or companies ar e ver y similar t o t he r ules t hat apply t o individuals. However , companies cont inue t o claim indexat ion allowance beyond 5 Apr il 1998 when it was f r ozen f or individuals. Companies ar e not eligible f or t aper r elief , nor ar e t hey ent it led t o an annual exempt ion.
C13.2 Computation of gains
The pr of or ma f or comput ing gains f or a company is shown below. We st ar t wit h sale pr oceeds f r om which we can deduct any incident al cost s such as solicit or ’s or sur veyor ’s f ees, et c.
We deduct t he cost of t he asset s which will also include any enhancement expendit ur e and ot her incident al cost s of acquisit ion. That gives us t he unindexed gain. We t hen deduct indexat ion allowance, which is an allowance f or inf lat ion, t o give t he indexed gain, which is t he gain we subj ect t o cor por at ion t ax. £ Proceeds X Less: cost (X) Unindexed gain X I ndexat ion allowance (X) I ndexed gain X
Corporat e Capit al Gains 193
Illustration 1
Viscount Limit ed sold a f act or y f or £ 1,200,000 on 30 Sept ember 2006. Solicit or s f ees amount ed t o £ 2,000. The f act or y had been pur chased in May 1992 at a cost of £ 350,000.
The capit al gain will be comput ed as f ollows: £
Proceeds 1,200,000 Less incident al selling cost s (2,000) 1,198,000 Cost (350,000) Unindexed gain 848,000 Indexation (£350,000 at, say, 50%) (175,000) I ndexed gain £ 673,000
C13.3 Indexation allowance
The indexat ion f act or is calculat ed by t aking t he movement in t he Retail Price Index (RPI ) between the date of acquisition of the asset and the date of sale. Wher e t her e is enhancement expendit ur e, we also look at t he movement in t he Ret ail Price I ndex bet ween t he dat e t he enhancement expendit ur e was incur r ed and t he dat e of disposal.
The RPI s ar e given in t he t ax t ables accompanying t his cour se.
The indexat ion f act or is comput ed using t he f or mula:
RPI at sale – RPI at acquisition RPI at acquisition
The r esult of t his is r ounded t o t hr ee decimal places or can be expr essed as a per cent age.
Illustration 2
I n t he pr evious illust r at ion, Viscount Limit ed, we assumed t he indexat ion f act or was 50%.
The cor r ect indexat ion f act or f or May 1992 t o Sept ember 2006 is:
197.0 – 139.3 139.3 = 0.414213926 = 0.414 (or 41.4%)
The cor r ect gain is t her ef or e: £ Unindexed gain 848,000 Indexation (£350,000 x 41.4%) (144,900) I ndexed gain £ 703,100
194 Principles of Business Taxat ion ‘Finance Act 2006’
Example 1
Crest a Limit ed pur chased a war ehouse in May 1989 f or £ 425,000 and incurred solicit or ’s and sur veyor ’s f ees on t his pur chase amount ing t o £ 2,000. St amp Dut y Land Tax was char ged at 3% on t he pur chase pr ice and t his was payable by Crest a Limit ed. The war ehouse is sold in J anuary 2007 f or £ 1.5 million and solicit or ’s f ees of £ 3,000 wer e incur r ed.
You ar e r equir ed t o calculat e t he indexed capit al gain assuming t he RPI in J anuar y 2007 is 198.6.
13.4 Enhancement expenditure
Enhancement expenditure is added to the “base cost”, or allowable cost , of t he asset . I t may need t o be indexed separ at ely if t he enhancement occur s in a mont h ot her t han t he mont h of acquisit ion of t he asset .
Illustration 3
Assume in t he Viscount Limit ed illust r at ion t hat t he f act or y was ext ended in Oct ober 1996 at a cost of £ 200,000. For simplicit y we will ignor e t he incident al selling cost s now.
£ Proceeds (Sept 2006) 1,200,000 Cost (May 1992) (350,000) Enhancement (Oct 1996) (200,000) Unindexed gain 650,000
I ndexat ion on cost May 1992 t o Sept 2006 197.0 – 139.3 (144,900) 139.3 = 41.4% x £ 350,000 I ndexat ion on enhancement Oct 1996 t o Sept 2006 197.0 – 153.8 153.8 = 28.1% x £ 200,000 (56,200) ______I ndexed gain 448,900
C13.5 Capital losses
Capital losses ar e comput ed in t he same way as capit al gains, except t hat indexat ion cannot cr eat e or incr ease a capit al loss, it can only reduce a gain to zero.
Corporat e Capit al Gains 195
Illustration 4
Assume in I llust r at ion 2 t hat t he asset was act ually sold f or just £ 400,000. £
Proceeds 400,000 Cost (350,000) Unindexed gain 50,000 I ndexat ion allowance: 41.4% x £ 350,000 = £ 144,900 rest rict ed t o (50,000) I ndexed gain nil
Illustration 5
Assume now t hat t he asset was act ually sold f or just £ 250,000. £
Proceeds 250,000 Cost (350,000) Allowable loss £(100,000)
No indexat ion is claimable as it cannot incr ease t his loss.
The capit al loss may be ut ilised against capit al gains in t he same year , or car r ied f or war d against f ut ur e char geable gains. The r elief f or capit al losses is dealt wit h lat er .
C13.6 Restriction on capital losses for companies S8 (2A)TCGA 1992
For disposals on or af t er 5 December 2005, ant i avoidance measur es have been int r oduced t o pr event companies using capit al losses t hat have ar isen f r om ar r angement s t he main pur pose or one of t he main pur poses of which is t o secur e a t ax advant age.
“Tax advant age” means r elief or increased r elief f r om cor por at ion t ax, S184D TCGA r epayment or incr eased r epayment of cor por at ion t ax, t he avoidance or 1992 r educt ion of a char ge t o cor por at ion t ax or an assessment t o cor por at ion t ax, or t he avoidance of a possible assessment t o cor por at ion t ax.
I n t he guidance not es issued by HMRC t he f ollowing example of ar r angement s is given.
Y plc is t he pr incipal company of a pr oper t y gr oup t hat includes a subsidiar y company X Lt d. X Lt d owns a pr oper t y in t he cent r e of London wit h a base cost of £ 1bn. The pr oper t y was pr eviously acquir ed f r om a f ellow group company at no gain/ no loss when t he mar ket value of t he pr oper t y st ood at £ 900m.
X Lt d issues shar es t o an unconnect ed party, B Ltd, to the extent that B Ltd holds 30% of t he issued shar e capit al of X Ltd and so X Ltd is no longer a member of t he Y plc gr oup.
196 Principles of Business Taxat ion ‘Finance Act 2006’
These new shar es have ver y r est r ict ed r ight s compar ed t o t hose alr eady in issue. The pr esence of only ver y r est r ict ed r ight s at t ached t o t he new shar es indicat es t hat Y plc has no int ent ion of making any mat er ial disposal of it s economic int er est in t he pr oper t y.
I n t he absence of t he new legislat ion t he f act t hat X Lt d is no longer par t of t he gr oup headed by Y plc t r igger s t he degrouping pr ovisions, and a capit al loss is r ealised, r ef lect ing t he pr evious f all in pr oper t y value of £ 100m.
I n t his example it is clear t hat Y plc has t aken advant age of t he st at e of t he pr oper t y mar ket in or der t o r ealise a loss f or t ax pur poses even t hough t her e has been no genuine disposal, eit her of t he asset whose value was r educed, or of t he company t hat owns it .
A loss has ar isen t o a company dir ect ly in consequence of ar r angement s, t he main pur pose of which is t o secur e a t ax advant age. New sect ion 8(2A) pr ovides t hat t he loss ar ises in disqualif ying cir cumst ances and is not t her ef or e an allowable loss.
I f , however , in t he above example B Lt d genuinely wished t o ent er int o a j oint vent ur e involving t he pr oper t y, t hen a dif f er ent out come can be expect ed. I t would have subscr ibed f or shar es t hat had r ight s compar able t o t hose in issue, so t hat it acquir ed a cor r esponding shar e of t he economic value of X Lt d. I n t hose cir cumst ances, secur ing a t ax advant age is unlikely to have been a main pur pose of t he t r ansact ion.
C13.7 Avoidance involving capital losses
For disposals on or af t er 5 December 2005 HMRC can issue a not ice t o a company S184G&H denying loss r elief if ar r angement s have been ent er ed int o t o conver t income t o TCGA 1992 capit al or secur e a deduct ion t hat would not ot her wise be available
I n bot h cases denial of t he loss only occur s on t he issue of a not ice by HMRC, t he company is not under any obligat ion t o self assess.
The not ice must
(a) specif y t he ar r angement s, (b) specif y t he account ing per iod in which t he r elevant gain accr ues, and (c) inf or m t he r elevant company of t he ef f ect of t his sect ion.
I f r elevant gains accr ue in mor e t han one account ing per iod, a single not ice under t his sect ion may specif y all t he account ing per iods concer ned.
Not ices may be issued bef or e or af t er t he company has f iled it s CT600. I f t he r et ur n has been made a not ice can only be issued once an enquir y has been opened. A not ice can also be issued under t he discover y r ules.
Corporat e Capit al Gains 197
Following t he issue of a not ice a company has 90 days t o consider t he impact on it s ret urn. I n t he case of an enquiry no closure not ice can be issued unt il t he 90 days expir es.
A return will be incorrect if it is not amended wit hin t he 90 days.
A clear ance pr ocedur e is available f or t r ansact ions which may be caught by t hese r ules.
C13.8 Assets purchased before 31 March 1982
Capit al gains and losses can be comput ed by compar ing t he calculat ion based on cost wit h t he calculat ion based on t he value of t he asset on 31 Mar ch 1982.
Consequent ly, if t he value of t he asset has r isen f r om t he t ime of pur chase t o Mar ch 1982, it will be advant ageous t o use t he Mar ch 1982 value.
We will pr epar e two calculations; one based on cost and one based on the March 1982 value. Wher e t his pr oduces two gains, we take the lower gain. I f t his gives us two losses or any ot her r esult , we t ake t he lower loss. Wher e we pr oduce one gain and one loss, t he answer will be zero.
I ndexat ion allowance r uns f r om Mar ch 1982 and is based on t he higher of t he cost or Mar ch 1982 value in bot h calculat ions.
I f t he company has submit t ed a “global r ebasing elect ion”, t he cost calculat ion need not be per f or med, as t he elect ion means t hat t he company will only use Mar ch 1982 values in t he comput at ions.
Illustration 6
Vent ur a Limit ed pur chased a f act or y in J une 1970 f or £ 80,000. I t was wort h £ 190,000 on 31.3.82. The f act or y is sold in Sept ember 2006 f or £ 500,000 when you should assume t he RPI f act or was 197.0.
Cost March 1982 £ £ Proceeds 500,000 500,000 Cost/March 1982 value (80,000) (190,000) Unindexed gain 420,000 310,000 I ndexat ion March 1982 t o Sept ember 2006 On higher of cost or Mar ch 1982 value 197.0 – 79.44 79.44 = 148.0% x £ 190,000 (281,200) (281,200)
I ndexed gain £138,800 £28,800
As t he t wo columns bot h pr oduce gains, t he lower is t aken i.e. £ 28,800
198 Principles of Business Taxat ion ‘Finance Act 2006’
Illustration 7
Assume now t hat inst ead t he asset was sold f or £ 400,000.
Cost March 1982 £ £ Proceeds 400,000 400,000 Cost (80,000) (190,000) Unindexed gain 320,000 210,000 Indexation: £190,000 x 148.0% (281,200) (210,000)* I ndexed gain £38,800 nil
* The indexat ion is rest rict ed so as not t o pr oduce a loss.
The lower amount is t aken i.e. nil.
C13.9 Rollover relief
Wher e a company sells one qualif ying asset and pur chases anot her qualif ying asset , wit hin a specif ied per iod, the gain on t he sale of asset 1 can be deducted f rom the base cost of asset 2 upon t he company making an elect ion. This will ensur e t hat t he company does not pay cor por at ion t ax on t he sale of t he f ir st asset .
These r ules only apply when t he company is selling asset s used f or t he pur poses of a t r ade. The Gover nment is keen t o encour age companies t o r einvest in t heir t r ading act ivit ies wit hout having t o pay cor por at ion t ax on gains along t he way.
Eligible asset s include: (i) Land and buildings (used in t he t r ade) (ii) Goodwill bought or creat ed prior t o April 2002 (iii) Fixed plant and machiner y - “Fixed” means bolt ed t o t he f loor or building.
Goodwill bought or cr eat ed af t er 1 Apr il 2002, is not wit hin t he CGT r ules as explained in t he chapt er on I FAs.
The specified period dur ing which asset 2 must be pur chased, is one year before the disposal of asset 1 to three years afterwards.
Fur t her det ails r egar ding r ollover r elief can be f ound in he next chapt er .
C13.10 Disposal of substantial shareholding
Disposals by a company of “subst ant ial shar eholdings” in ot her companies ar e exempt f r om t ax. Consequent ly gains ar e not t axable and losses ar e not allowable when dealing wit h disposals of subst ant ial shar eholdings.
Corporat e Capit al Gains 199
The r ules apply t o shar eholdings in bot h UK r esident and non-r esident companies.
A subst ant ial shar eholding is def ined as 10% or more of a company’s or dinar y shar e capit al. The or dinar y shar es held must also give ent it lement t o at least 10% of t he company’s dist r ibut able pr of it s and 10% of asset s on a winding up. For t hese pur poses t he holdings of ot her gr oup member s ar e t aken int o account .
To qualif y
(i) A subst ant ial shar eholding must have been held f or at least 12 months in a per iod beginning not lat er t han t wo year s bef or e t he sale t akes place. (ii) t he invest ing company must eit her be a sole t r ading company or t he member of a t r ading gr oup. For t hese pur poses t he def init ion of t r ading company is t he same as t hat used f or t aper r elief . (iii) t he shar es must be in a qualif ying company which is a def ined as a t r ading company or a member of a t r ading gr oup.
Condit ions (ii) and (iii) must apply in t he lat est 12 mont h per iod in which t he subst ant ial shar eholding t est has been sat isf ied and ending wit h t he t ime of t he disposal AND immediat ely f ollowing t he disposal.
These r ules ar e cover ed in mor e det ail in a lat er chapt er .
Answer 1
£ £
Proceeds 1,500,000 Incidental costs (3,000) Net sale pr oceeds 1,497,000
Cost 425,000 Incidental costs 2,000 Stamp duty land tax (£425,000 x 3%) 12,750 Total cost (439,750) Unindexed gain 1,057,250 I ndexat ion May 1989 t o J anuary 2007 198.6 – 115 115 = 72.7% x £ 439,750 (319,698) I ndexed gain £737,552
200 Principles of Business Taxat ion ‘Finance Act 2006’
SUMMARY – CORPORATE CAPITAL GAINS
I ndexat ion allowance did not cease f or companies on 6 Apr il 1998.
Companies do not get t aper r elief or an annual exempt ion.
Ther e ar e r est r ict ions on losses ar ising f r om ar r angement s, t he main pur pose of which or one of t he main pur poses of which is t o secur e a t ax advant age.
Rollover r elief is available when qualif ying asset s ar e disposed of and t he pr oceeds ar e r einvest ed in ot her qualif ying asset s.
Goodwill bought or cr eat ed af t er 1 Apr il 2002 is not an eligible asset f or r ollover r elief f or companies.
Fr om 1 Apr il 2002, gains on t he disposal of subst ant ial shar eholdings will be exempt .
Subst ant ial is def ined as 10% or more. A 10% holding must have been held f or at 12 mont hs in t he pr eceding t wo year s. The company making t he sale and t he company whose shar es ar e being sold must bot h be t r ading companies.
C14: ROLLOVER RELIEF
I n t his chapt er you will look at t he gener al pr inciples of r ollover r elief including: - how t he r elief oper at es; - pr oceeds not f ully r einvest ed; - condit ions f or t he relief ; - qualif ying asset s; - t ime limit s.
C14.1 Introduction
You will somet imes see r ollover r elief r eferred to as “replacement of business s. 152 asset s” r elief , f or t he simple r eason t hat t he legislat ion gives a company r elief when he sells a business asset and replaces it with another.
Illustration 1
A company is using a building f or t he pur poses of it s t r ade. I t sells t he building f or £ 200,000 making a capit al gain – bef or e any r elief s – of £ 80,000. The r eason t he company has sold t he old asset , is because it wishes t o r eplace it wit h a new one. The company may be expanding and needs lar ger pr emises.
The company r eplaces t he old of f ice building wit h a new of f ice building cost ing £ 250,000. Wher e a company disposes of a business asset and r einvest s t he pr oceeds in buying anot her business asset , t he company can make a claim t o def er t he gain it has made. I n t his example, t he company sells it s old asset f or £ 200,000 and r einvest s t he whole of it s pr oceeds in buying a new asset f or £ 250,000. The company has t her ef or e not r et ained any of t he sale pr oceeds.
As all proceeds are reinvested, full rollover relief is given as below. s. 152(1)
£ Proceeds 200,000 Cost (100,000) Indexation (say) (20,000) Gain 80,000 Roll over relief (80,000) Gain Nil
Rollover r elief is a def er r al r elief as it pushes t he capit al gains back t o a lat er per iod in t ime. The way r ollover r elief wor ks, is t hat t he amount of t he gain s. 152(1)(b) deferred – in t his inst ance £ 80,000 – is rolled over and reduces the base cost of the new asset purchased.
202 Principles of Business Taxat ion ‘Finance Act 2006’
New building: £ Cost 250,000 Rolled over gain (80,000) Base cost of new asset £ 170,000
Ther ef or e when t he company comes t o sell t he second building, because it s base cost has been r educed by £ 80,000, t he capit al gain on t he sale of t hat building will be uplif t ed by £ 80,000. Theref ore t he capital gain of £ 80,000 on t he sale of building number 1, has been deferred until the sale of building number 2. The advant age of making a r ollover r elief claim, is t hat t he company can elect t o pay t ax on t his £ 80,000 sever al year s lat er , t her ef or e obt aining a cash f low advant age.
C14.2 Proceeds not fully reinvested s.153
Illustration 2
Assume a company sells a business asset f or £ 200,000 r ealising a capit al gain of £ 80,000. The company uses t he money t o buy a r eplacement asset which cost s £ 180,000. You will see t her ef or e, t hat t he company has not f ully r einvest ed it s pr oceeds of sale.
Cash ret ained = £ 200,000 – 180,000 = £ 20,000
Wher e t he company does not spend all of t he sale pr oceeds, t he amount of cash retained (£ 20,000) is immediately chargeable t o capit al gains t ax. This amount is the gain before taper relief. This means that having made a capital gain of £ 80,000, t he company is immediat ely charged on £ 20,000. The balance – her e being £ 60,000 – is the rollover relief t hat t he company can claim. £ Proceeds 200,000 Cost (100,000) I ndexat ion (20,000) Gain 80,000 Roll over r elief (60,000)
Gain £ 20,000 (£ 200,000 – 180,000)
The £ 60,000 will be r olled over and r educes t he base cost of t he new asset .
£ Cost 180,000 Rolled over gain (60,000) Base cost of new asset £ 120,000
Rollover Relief 203
Illustration 3
Assume a company sells a business asset f or £ 200,000, r ealising a capit al gain of £ 80,000. The company uses par t of t he sale pr oceeds t o buy a r eplacement asset . The new building is consider ably smaller and cost s £ 110,000. Wher e a company has not f ully r einvest ed his proceeds of sale, we must ident if y t he amount of cash r et ained.
Cash r et ained = £ 200,000 – 110,000 = £ 90,000
However it is not possible f or t he Revenue t o char ge t he company on a gain of £ 90,000, as t he act ual gain is only £ 80,000. Ther ef or e t he whole of t his gain of £ 80,000 will be immediat ely charged t o t ax, and no r ollover r elief will be available. The base cost of t he new asset will r emain at £ 110,000.
This demonst r at es t hat when t he cash retained by the company exceeds the capital gain, t he whole of t he gain is char geable and no rollover relief can be claimed. £ Proceeds 200,000 Cost (100,000) I ndexat ion (20,000) Gain 80,000 Roll over r elief Nil Gain 80,000
Base cost of new asset £ 110,000
C14.3 Conditions for the relief
Rollover r elief can only be claimed by company if it sells an asset and r einvest s t he pr oceeds in a r eplacement asset . Rollover r elief can also be claimed by s. 152(1) persons carrying on a trade. I ndividuals t r ading as sole t r ader s or wit hin a par t ner ship can claim r ollover r elief .
The old asset – i.e. t he asset being sold – must be used for the purposes of a business car r ied on by t he company. Rollover r elief is also available wher e an individual owns an asset , but t he asset is used by his per sonal company. (i.e. wher e t he individual owns at least 5% of t he vot ing shar es).
The new asset – i.e. t he asset being acquir ed – must be immediately taken into ESC D24
use for the purposes of the trade. I t is not possible f or a company t o buy an
asset , and use it f or non-t r ading pur poses if r ollover r elief is t o be claimed.
I f an individual is car r ying on t wo t r ades at t he same t ime, t hese two trades are regarded as one single trade f or r ollover r elief pur poses. Ther ef or e if an s. 152(8) individual makes a capit al gain on an asset used in t r ade “A”, he can claim r ollover r elief by buying a business asset and using it f or t he pur poses of t r ade “B”.
204 Principles of Business Taxat ion ‘Finance Act 2006’
C14.4 Qualifying assets
Rollover r elief is only available t o a company who makes a disposal of a s. 155 “qualif ying asset ”, and who r einvest s all or par t of t he pr oceeds in anot her “qualif ying asset ”. The legislat ion cont ains a list of qualif ying asset s at s.155 TCGA 1992.
The most common t ype of qualif ying asset s is land and buildings used f or t he pur poses of a t r ade. These will t ypically include shops, of f ices, f act or ies, war ehouses et c.
Fixed plant and machinery ar e qualif ying asset s f or r ollover r elief . Not e t he wor d “f ixed”. Fixed means immovable, so asset s such as t r act or s or combine har vest er s used by a f ar mer , or vehicles used by t r ader s, will not be eligible f or r ollover r elief .
Ships, air cr af t and hover cr af t ar e qualif ying asset s as ar e sat ellit es, space st at ions and spacecr af t . Milk, pot at o and f ish quot as will also qualif y f or r ollover r elief , as will ewe and cow suckler pr emiums.
The qualif ying asset s you ar e most likely t o see in pr act ice ar e t he t op t wo in t he list – land and buildings or f ixed plant and machinery.
I t is impor t ant t o not e t hat t he old and the new assets do not need to fall within the same category. I f a company makes a gain on t he sale of a building, it will obt ain rollover relief if it purchases eit her anot her building, or any of t he ot her qualif ying asset s. Ther ef or e a company t hat sells a milk quot a and r einvest s t he pr oceeds in space t r avel, will obt ain r ollover r elief .
One asset you will not find on the list of qualif ying asset s is shares. If an company eit her buys or sells shares, it will not be able to claim rollover relief. Shar es can never be used f or t he pur poses of a t r ade. A shar e is simply an invest ment in a company, and is not used f or any specif ic pur pose.
C14.5 Statutory time limits
Rollover r elief is only available if t he new asset is acquir ed wit hin a cer t ain s. 152(3) per iod of t ime. The new asset must be acquired wit hin a f our year t ime window, r unning from 12 months before the sale of the old asset, to 36 months afterwards. These t ime limit s can be ext ended at t he discr et ion of t he Revenue.
Rollover relief must be claimed by t he company wit hin a cer t ain t ime limit . s. 43(1) TMA 1970 That t ime limit is six years from the end of the company’s accounting period. For example, us assume a company sells t he old asset in it s year ended 31 December 2007. A r ollover r elief claim should t her ef or e be made no lat er t han 31 December 2013.
Provisional claims f or rollover relief will be allowed. Ther ef or e if t he above s. 153A company sells an asset in 2006, but has not bought t he new asset by 31 Rollover Relief 205
December 2007, but is int ending t o buy t he asset bef or e t he t hr ee year r einvest ment per iod has expir ed, t he Revenue will allow t he company t o def er t he capit al gain, even t hough pr oper comput at ions cannot be pr epar ed.
Rollover r elief is not aut omat ic, and if a company does not wish t o def er a capit al gain, it will simply not make a rollover relief claim. This may be the case if the gain is cover ed by losses.
Example 1
Which of the below assets are qualifying assets for rollover relief purposes?
(a) Fr eehold of f ice (b) Lease on a f act or y (c) Tractor (d) Shar es in a per sonal company (e) Paint ing
Example 2
X Lt d bought a shop in May 1994 f or £ 180,000. I t sold it in May 2006 f or £ 250,000. I n June 2005 X Lt d had bought a hovercraf t f or use in its trade f or £ 230,000. I t sold t he hovercraf t in March 2007 f or £ 240,000.
X Lt d has a 31 Mar ch year end.
Assuming all claims are made calculate X Ltd’s chargeable gains in the year ended 31 March 2007.
Ignore indexation.
206 Principles of Business Taxat ion ‘Finance Act 2006’
Answer 1
Qualif ying Asset ? Yes No a) Fr eehold of f ice b) Lease on f act or y c) Tractor X (Not fixed) d) Shar es in Per sonal Co. X e) Paint ing X (Not used in t r ade)
Answer 2
May 2006 Gain on shop £ Proceeds 250,000 Less: Cost (180,000) Gain 70,000 Rollover relief (50,000) Gain 20,000 (250,000-230,000)
Hovercraf t £ Cost 230,000 Rolled over gain (50,000) Base cost of new asset 180,000
March 2007 Gain on Hovercraft £ Proceeds 240,000 Less: base cost (above) (180,000) Gain 60,000 Add: Gain on shop 20,000 Char geable gains £ 80,000
Rollover Relief 207
SUMMARY – ROLLOVER RELIEF
Rollover r elief applies when a company sells one business asset and r eplaces it wit h anot her .
I f all t he pr oceeds f r om t he sale of t he old asset ar e r einvest ed in t he new asset , t he gain on t he old asset is not char ged but inst ead is deduct ed f r om t he base cost of t he new asset . Ther e will t her ef or e be a bigger gain in t he f ut ur e when t he new asset is sold.
I f pr oceeds ar e not f ully r einvest ed a gain equal t o t he cash r et ained must be left char geable.
Rollover r elief is available t o companies and per sons car r ying on a t r ade. The old and t he new asset must bot h be used in t he t r ade.
Qualif ying asset s include: Land and buildings Goodwill (f or individuals only) Fixed plant and machiner y Ships/ aircraf t/ hovercraf t Sat ellit e/ space st at ions/ space cr af t Milk/ pot at o/ f ish quot as
Shar es ar e not a qualif ying asset f or r ollover r elief .
The new asset must be acquir ed 12 mont hs bef or e t o 36 mont hs af t er t he sale of t he old asset .
A claim must be made f or r ollover r elief by six year s f r om t he end of t he account ing per iod. Provisional claims can be made.
C15: SHARES AND SECURITIES: MATCHING RULES
I n t his chapt er you will cover t he r ules t hat apply when a company sells shar es including: - t he mat ching r ules; - t he FA 1985 pool; - t he 1982 holding.
C15.1 Introduction
Bef or e we examine t he special r ules f or shar es, let us spend a f ew moment s discussing why we need t hem in t he f ir st place. Consider a company who has been buying shar es in a quot ed company called XYZ Plc f or a number of year s. The shar e pur chases have been as f ollows:
Date Shar es Cost December 1975 1,000 £ 1,000 June 1986 3,000 £6,000 September 1990 2,000 £8,000 December 1999 4,000 £20,000 Tot al 10,000 £35,000
The company cur r ent ly has 10,000 shar es, which have been acquired in four tranches bet ween 1975 and 1999 and t he t ot al cost of t he t axpayer ’s shar eholding is £ 35,000.
I n August 2006, t he company sells 6,500 of t he XYZ Plc shares f or t ot al pr oceeds of £ 39,000.
I n or der t o calculat e t he char geable gain ar ising on t he sale of t hese 6,500 shar es, we need to identify exactly which shares the company has sold. Unt il we know exact ly which shar es have been sold, we cannot ident if y t he base cost of t he shar es, and we cannot t her ef ore wor k out t he indexat ion allowance.
The share “matching” rules det er mine t he exact or der in which shar es ar e I R 218 Tax Bullet in deemed t o have been sold. The “mat ching” r ules we ar e about t o st udy, apply No. 52 for companies only. Ther e ar e slight ly dif f er ent mat ching r ules f or disposals (April 2001) of shar es by individuals. Also not e t hat t he “mat ching” r ules only apply to shares in the same class in the same company. We should never mix up dif f er ent t ypes of shar es in dif f er ent companies.
Shar es and Secur it ies: Mat ching Rules 209
C15.2 The share matching rules
Ther e ar e 6 mat ching r ules, and we shall cover t hem in t heir order of priorit y:
(1) I f a company disposes of shar es, it is first deemed t o have sold any shar es acquir ed on t he same day.
(2) Wher e t he company owns at least 2% of t he issued shar e capit al of anot her company, it is deemed t o have disposed of shar es acquir ed in t he previous
month (lat est f ir st ), t hen shar es acquir ed in t he following month (ear liest f ir st ). This r ule will not be seen ver y of t en.
(3) Wher e (2) does not apply, t he company is deemed t o have sold any shar es it acquir ed in t he previous 9 days. Even if t his acquisit ion was in t he pr evious mont h, no indexation allowance is available t o r educe t he gain.
(4) Next t he disposal will be mat ched wit h shar e acquisit ions bet ween 1 April 1982 and 10 days before the sale. Shar es bought in t his per iod, ar e
pooled t oget her and f or m one asset f or gains pur poses. Shar es acquir ed bet ween t hese dat es, ar e held in what we call t he “Finance Act 1985 pool”.
(5) Next the company is deemed to have sold shares which it bought between April 1965 and April 1982. Shar es bought bet ween t hese t wo dat es ar e pooled t oget her in what we call t he “1982 pool” or t he “1982 holding”.
(6) Finally t he company is deemed t o have sold shar es acquir ed before 6 April 1965. These r ules apply ver y r ar ely and will not be cover ed on t his cour se.
Illustration 1
Tolley Lt d has acquir ed shar es in Glaxo Smit hKline plc as f ollows:
Dat e Shar es Cost £ 1 December 1992 6,000 6,000 1 July 2000 4,000 8,000 25 February 2007 2,000 5,000 12,000 19,000
On 1 March 2007, Tolley Lt d sold 7,000 of t he shares f or gr oss pr oceeds of £ 21,000. To calculat e t he capit al gain, we must f ir st ident if y which shar es have been sold, by applying t he shar e mat ching r ules.
Tolley Lt d sold t he shares on 1 March 2007. Our f ir st quest ion is “did t he company buy any shar es on t he same day” – i.e. did it buy any shar es on 1 Mar ch 2007? I f it did, t hese shares will be sold in pr ior it y t o any ot her s.
210 Principles of Business Taxat ion ‘Finance Act 2006’
The answer t o t his quest ion is “no”. We t her ef or e move t o t he second mat ching rule. 12,000 shares is clearly not more than 2% of the shares of a major plc, so r ule (2) can be ignor ed. This will ver y of t en be t he case.
We next ask our selves whet her Tolley Lt d bought any shar es in t he 9 days before t he dat e of disposal – i.e. bet ween 20 February and 28 February 2007.
The answer t o t his quest ion is “yes” - Tolley Lt d did buy some shares in t his per iod – it bought 2,000 shar es on 25 Febr uar y 2007. We t her ef or e have a “mat ch”. What we ar e saying her e, is t hat of t he 7,000 shar es sold on 1 Mar ch 2007, t he first ones t o be sold wer e t hose bought on 25 Febr uar y 2007.
We now move down to matching rule number (4). The next match, is with any shar es acquir ed bet ween 1 April 1982 and 19 February 2007.
Tolley Lt d has bought t wo lot s of shar es in t his per iod – 6,000 shar es in December 1992 and 4,000 shar es in J uly 2000. These ar e “pooled” t oget her t o f or m one single bunch of shar es. These shar es f or m t he “FA 1985 pool”. On 1 March 2007 Tolley lt d s deemed t o have sold 5,000 of t he 10,000 shares in t his “pool”.
This can be summar ised as below:
Dat e FA 1985 pool Prior 9 days
1 December 1992 6,000 1 July 2000 4,000 25 February 2007 _____ 2,000 10,000 2,000 Sale 1 March 2007 (5,000) (2,000)
2nd “mat ch” 1st “mat ch”
Once we have a “match”, the next step is t o calculat e t he r esult ing char geable gain. I n t his quest ion, we have 2 matches, which means we will need t o pr epar e 2 capital gains computations.
At f ir st sight t his seems a ver y complicat ed exer cise, but you will quickly become f amiliar wit h t he pr ocess once you have done a f ew pr act ice quest ions.
Let us now calculat e Tolley Lt d’s capit al gain on t he sale of t he 7,000 Glaxo Smit hKline Plc shar es on 1 Mar ch 2007.
Shar es and Secur it ies: Mat ching Rules 211
The f ir st mat ch is wit h 2,000 shar es, bought on 25 February 2007:
£ Disposal 1: Proceeds 2000 £ 21,000 x 7000 6,000 Less: cost (25.2.07) (5,000) Gain £1,000
Not e t hat even t hough t he shares were bought in February and sold in March, as t he “9 day” r ule applies, no indexation is available.
The second mat ch is wit h 5,000 in t he FA 1985 pool.
£ Disposal 2: Proceeds 5000 £ 21,000 x 7000 15,000 Less: cost ? Less; indexat ion ? Gain X
To ascer t ain t he cost of t he shar es sold (and t he indexat ion allowance), we need t o put t oget her t he “FA 1985 pool”.
C15.3 Share pooling
Shar es acquir ed in t his per iod ar e grouped together in “the Finance Act 1985 pool”. This is so called because t he shar e pooling r ules wer e or iginally int r oduced in t he 1985 Finance Act .
I f we ar e calculat ing gains on shar es acquir ed af t er Apr il 1982, we under t ake a pr ocess known as “shar e pooling”. Shar es acquir ed since Apr il 1982 ar e treated as one single asset f or capit al gains pur poses.
The FA 1985 pool cont ains shar es bought since Apr il 1982 and in t he illust r at ion of Tolley Lt d (above) will look like t his:
We will use t he f ollowing RPI s: December 1992 139.2 July 2000 170.5 March 2007 186.4
212 Principles of Business Taxat ion ‘Finance Act 2006’
Shar es Cost I ndexed cost £ £ December 1992 - buy 6,000 6,000 6,000 Indexed rise: Dec 1992 to July 2000 170.5-139.2 x £ 6,000 139.2 1,349 7,349 July 2000 - buy 4,000 8,000 8,000 10,000 14,000 15,349 Indexed rise: July 2000 to March 2007 186.4-170.5 X £ 15,349 170.5 ______1,431 10,000 14,000 16,780 March 2007 – sell (5,000) (7,000) (8,390) Balance 5,000 £ 7,000 £ 8,390
Let us f ir st look at t he number of shar es in t he pool. I n December 1992, Tolley Lt d bought 6,000 shar es. I t bought a f urt her 4,000 shares in July 2000. The t ot al number of shar es in t he “1985 pool” is t her ef or e 10,000.
I n March 2007, Tolley Lt d sold 5,000 shares out of t he 1985 pool. This means t hat af t er t he sale, t he balance of shar es in t he pool will be 5,000.
The second column shows t he acquisit ion cost of t he shar es. The 6,000 shar es bought in December 1992 cost £ 6,000. The 4,000 shares bought in J uly 2000 cost £ 8,000. The base cost of t he 10,000 shar es in t he pool is t her ef or e £ 14,000.
5,000 shar es – i.e. exact ly half t he number of shar es in t he pool – have been sold. I f t he cost of 10,000 shar es is £ 14,000, t hen t he cost of 5,000 shar es is exact ly half of t his – i.e. £ 7,000. Having removed half of the shares from the pool, we also take out half of the base cost. This leaves 5,000 shar es r emaining in t he pool wit h a base cost of £ 7,000.
We have now ident if ied t he base cost of t he 5,000 shar es being sold. Tr y not t o lose sight of what you ar e doing. The obj ect ive is t o calculat e t he capit al gain on t he sale of t hese 5,000 shar es. To calculat e t he capit al gain, we need the base cost. The base cost is t her ef or e £ 7,000, and t his will be ref lect ed in t he capit al gains comput at ion.
The f inal f igur e we need t o complet e t he comput at ion, is t he indexation allowance. We deal wit h indexat ion allowance in t he “1985 pool” in a special way, by having a separate column in which we calculat e t he indexat ion. We call t his column “indexed cost ”. Rat her t han dealing wit h indexat ion at t he end – i.e. wit hin t he capit al gains comput at ion – when we ar e const r uct ing t he 1985 pool, we accrue indexation as we go along.
Shar es and Secur it ies: Mat ching Rules 213
What we ent er int o t he “indexed cost ” column, is t he cost of t he shar es plus accrued indexation. This means that when we have finished constructing the 1985 pool, we will have all of t he numbers – i.e. t he pr oceeds, t he cost and t he indexat ion allowance – t o enable us t o calculat e t he capit al gain.
As the “indexed cost” column is made up of cost plus indexation allowance, any f igur es t hat go int o t he middle column – i.e., t he “cost ” column - must also go int o t he “indexed cost ” column.
You will see t hat in December 1992 t he shar es have a base cost of £ 6,000 and an indexed cost of £ 6,000. The next st ep is t o accr ue some indexat ion. Indexation is calculated between “operative events”. An “operative event” is any event that either increases or decreases the base cost of t he shar es.
The next oper at ive event af t er December 1992 is t he pur chase of shar es in J uly 2000. We comput e t he indexat ion allowance bet ween t hese t wo dat es. The “indexed r ise” bet ween December 1992 and J uly 2000 is £ 1,349.
Ther ef or e, at J uly 2000, t he indexed cost of t he shar es is t he cost plus t he accr ued indexat ion, being £ 7,349.
When calculat ing t he indexat ion allowance f or shar es in t he “1985 pool”, t her e is no need to round the indexation factor t o t hr ee decimal places. This is t he one and only time when we do not round the indexation factor.
Tolley Lt d bought 4,000 shares f or £ 8,000 in July 2000. This cost of £ 8,000 will also go int o t he indexed cost column, giving a t ot al indexed cost of £ 15,349.
The next st ep is t o wor k out indexat ion bet ween J uly 2000 and t he next oper at ive event . The next event in t he 1985 pool is t he sale of shar es in Mar ch 2007. I ndexat ion will t heref ore be accrued bet ween J uly 2000 and March 2007.
This indexat ion f act or is t hen mult iplied by £ 15,349 – i.e. t he indexed cost of t he shares as at July 2000. The accrued indexat ion bet ween t hese point s is £ 1,431, giving a t ot al indexed cost of t he shar es of £ 16,780. This f igur e is simply t he act ual cost of £ 14,000, plus £ 2,780 of accr ued indexat ion.
Tolley Lt d sold half of t he 1985 pool shar es, so we have r emoved half of t he base cost f r om t he 1985 pool. We must similar ly remove half of the indexed cost from the pool.
The indexed cost t o be r emoved f r om t he pool is t her ef or e £ 8,390. This t ells us t hat af t er selling t he shar es in March 2007, Tolley Lt d is lef t wit h 5,000 shar es, wit h a base cost of £ 7,000 and an indexed base cost of £ 8,390. The f igur e we have j ust r emoved f r om t he pool – i.e. t he £ 8,390 – is t he cost , plus t he accr ued indexat ion, of t he 5,000 shar es sold in March 2007. This f igure will t hen be r ef lect ed in t he capit al gains comput at ion.
214 Principles of Business Taxat ion ‘Finance Act 2006’
C15.4 Calculating the gain on the 1985 pool shares
Having const r uct ed t he 1985 pool, t he next st ep is t o wor k out t he char geable gain. I f we look back at t he pool, you will see t hat in March 2007, Tolley Lt d sold 5,000 shar es, t hey have a base cost of £ 7,000, and an indexed cost of £ 8,390. This f igur e is simply cost plus accr ued indexat ion. Ther ef or e t he indexation allowance, is the indexed cost minus the actual cost, being £ 1,309.
Proceeds £ 5000 £ 21,000 x 7000 15,000 Less: cost (7,000) Less: indexat ion (8,390 – 7,000) (1,390) Gain on 1985 pool shar es £ 6,610
A slight ly quicker way t o calculat e t his char geable gain is by deduct ing t he indexed cost f r om t he sale pr oceeds. As you will see, t his gives t he same gain – i.e. £ 6,610. This is a per f ect ly accept able shor t cut , but r emember t hat indexation cannot create a capital loss, so you will have t o be careful if indexed cost exceeds sale proceeds.
£ Proceeds 15,000 Indexed cost (cost plus indexat ion) (8,390) Gain on 1985 pool shar es £ 6,610
The t ot al gain on t he sale of t he 7,000 shares in March 2007 is t heref ore:
£ Gain 1: Shar es bought 25.2.07 1,000 Gain 2: Shar es f r om 1985 pool 6,610 Char geable gains 7,610
C15.5 Shares bought before 1 April 1982
Shar es bought between April 1965 and April 1982 f or m t he “1982 holding”. As is t he case f or t he 1985 pool, shar es acquir ed bet ween 1965 and 1982 ar e pooled t oget her t o f or m one single asset . The main dif f er ence bet ween t he 1982 holding and t he 1985 pool, is t hat in t he 1982 holding we do not accrue indexation within the pool. I ndexat ion allowance is dealt wit h at t he end in t he capit al gains comput at ion. The r eason we do t his, is because indexat ion allowance only came int o ef f ect f r om Mar ch 1982.
Shar es and Secur it ies: Mat ching Rules 215
The ot her issue t o consider in r elat ion t o t he 1982 holding, is March 1982 r ebasing. Whenever an asset is acquir ed bef or e Mar ch 1982, we need t o compute an alternative gain using the value of the asset in March 1982. This pr inciple applies in t he same way when t he asset in quest ion is shar es.
Illustration 2
Halsbur y Lt d has been buying shar es in a quot ed company, Chancer y plc. Halsbur y Lt d has acquir ed t he shar es in var ious st ages since 1975 as f ollows:
Date Shar es Cost £ 2.9.75 12,000 6,000 1.4.78 8,000 8,000 21.12.90 6,000 12,000 12.3.92 3,000 9,000 28.7.00 1,000 5,000 Total 30,000 £ 40,000
The shar es wer e wor t h £ 1.50 each in Mar ch 1982. The shar es r epr esent a 0.1% holding.
Halsbur y Lt d sold 15,000 shar es in November 2006 f or £ 90,000. To calculat e t he capit al gain in November 2006, we f ir st consider t he mat ching r ules:
Same day? X Previous 9 days? X 1985 Pool? 10,000 shar es bought bet ween 1982 and 2004 1982 Pool? 5,000 of t he 20,000 shar es bought bef or e 1982 15,000
We will pr epar e t wo CGT comput ations, one f or each “mat ch”.
Assume t he f ollowing RPI s; March 1982 79.44 December 1990 129.9 March 1992 136.7 July 2000 170.5 November 2006 185.6
216 Principles of Business Taxat ion ‘Finance Act 2006’
1982 Gain 1 – 10,000 shar es in FA 1985 pool;
The 1985 pool is const r uct ed as f ollows:
Shar es Cost I ndexed cost £ £ December 1990 6,000 12,000 12,000 I ndexed r ise 136.7-129.9 628 x £ 12,000 129.9 12,628 March 1992 3,000 9,000 9,000 9,000 21,000 21,628 I ndexed r ise 170.5-136.7 x £ 21,628 136.7 5,348 26,976 July 2000 1,000 5,000 5,000 10,000 26,000 31,976 I ndexed r ise 185.6-170.5 2,832 x £ 31,976 170.5 34,808 Sale (Nov 2006) (10,000) (26,000) (34,808) Nil Nil Nil
Gain:
Proceeds £ 10000 £ 90,000 x 15000 60,000 Less: cost (26,000) Less: indexation (34,808 – 26,000) (8,808) Gain on 1985 pool shar es £ 25,192
1982 Gain 1 – 5,000 shar es in 1982 pool;
12,000 shar es wer e bought in Sept ember 1975 f or £ 6,000. 8,000 shar es wer e bought in April 1978 f or £ 8,000. We t her ef or e have 20,000 shar es wit h a combined cost of £ 14,000.
5,000 of t hese 20,000 shar es ar e being sold in November 2006. The balance of shar es in t he 1982 holding, is t her ef or e 15,000.
One-quarter of the shares in the pool have been sold. Ther ef or e we must remove one-quarter of the base cost – i.e. £ 3,500 – leaving t he r emaining shar es in t he pool wit h a combined cost of £ 10,500.
Shar es and Secur it ies: Mat ching Rules 217
As t he shar es wer e held as at 31 Mar ch 1982, we ar e int er est ed in t heir 1982 mar ket value. The shar es wer e wor t h £ 1.50 each in March 1982. The 20,000 shar es in t he pool wer e t her ef or e wor t h £ 30,000 in March 1982. The essent ial pr inciple of Mar ch 1982 r ebasing, is t hat we pr et end t hat t hese 20,000 shar es had been bought in 1982 f or £ 30,000.
Shares Cost 1982 Value £ £ September 1975 12,000 6,000 April 1978 8,000 8,000 20,000 14,000 30,000 Sale (Nov 2006) = 5,000 shares (5,000) (3,500) (7,500) Remaining 15,000 10,500 22,500
As we have r emoved one-quar t er of t he shar es and one-quar t er of t he cost f r om t he pool, we must also remove the same proportion of March 1982 value. The Mar ch 1982 value of t he 5,000 shar es being sold is £ 7,500, and t his is r emoved f rom t he 1982 holding.
Finally we calculat e t he gain on t he sale of 5,000 shar es in t he 1982 holding. As is always t he case f or asset s acquir ed bef or e Mar ch 1982, we will pr epar e t wo comput at ions, one using cost t he ot her using 1982 mar ket value.
Disposal 2; Cost 82MV £ £ Proceeds 5000 £ 90,000 x 15000 30,000 30,000 Less: cost (3,500) Less: 1982 value ______(7,500) 26,500 22,500 Less: indexat ion 185.6-79.44 (10,020) (10,020) (1.336) x £ 7,500 79.44 Gain on 1982 pool shar es £ 16,480 £ 12,480
Take lower gain £ 12,480
Summar y of Gains: £ 10.000 shar es 1985 pool 25,192 5,000 shar es 1982 holding 12,480 15,000 ______Tot al gains £ 37,672
218 Principles of Business Taxat ion ‘Finance Act 2006’
C15.6 The “substantial shareholding” exemption
Fr om 1 Apr il 2002, disposals by companies of “subst ant ial shar eholdings” in ot her companies ar e exempt from corporation tax, so no gain / loss needs t o be calculat ed.
A “subst ant ial” shar eholding is 10% or more of t he or dinar y shar e capit al.
To qualif y f or t he exempt ion, t he subst ant ial shar eholding must have been held for at least 12 months in t he t wo year s up t o t he dat e of t he disposal.
Ther ef or e, when consider ing t he shar e mat ching / shar e pooling r ules above, first check whether the selling company are holding at least 10% of the shar es of t he company in which t hey have invest ed. I f so, t her e is no r equir ement t o calculat e t he gain.
I n pr act ice, wher e companies ar e holding shar es in quot ed plc’s as an invest ment t o gener at e dividend income, t he shar eholding will invar iably be a ver y small per cent age so t he shar e mat ching / pooling r ules will apply.
Shar es and Secur it ies: Mat ching Rules 219
Example 1
Pool-I t Lt d acquir ed shar es in XYZ plc on t he f ollowing dat es:
Date Shar es Cost £ 1.11.87 1,000 10,000 2.3.90 2,000 30,000 1.1.98 3,000 60,000
Pool-I t Lt d sold 1,500 shar es in November 2006 f or £ 45,000.
Assume t he f ollowing RPI s;
November 1987 103.4 March 1990 121.4 J anuar y 1998 159.5 November 2006 185.6
Calculate the chargeable gain.
Example 2
Nexis Lt d had t he f ollowing shar e t r ansact ions in TAX plc.
Dat e Shar es Event Cost Proceeds £ £ 12.5.74 2,000 Buy 6,000 13.6.75 3,000 Buy 9,000 14.7.76 5,000 Buy 10,000 25.9.2006 1,000 Buy 6,500 28.9.2006 3,000 Sell £18,000
The shar es wer e wor t h £ 2 each at Mar ch 1982.
Assume t he f ollowing RPI s:
March 1982 79.44 Sept ember 2006 185.2
Calculate Nexis Ltd’s chargeable gain.
220 Principles of Business Taxat ion ‘Finance Act 2006’
Answer 1
Mat ch wit h shar es in FA 1985 pool:
Shar es Cost I ndexed Cost (Cost + I A) £ £ November 1987 - buy 1,000 10,000 10,000 I ndexed r ise 121.4-103.4 1,741 x 10,000 103.4 11,741
March 1990 - buy 2,000 30,000 30,000 3,000 40,000 41,741 I ndexed r ise 159.5-121.4 13,100 x 41,741 121.4 54,841
January 1998 - buy 3,000 60,000 60,000 6,000 100,000 114,841 I ndexed r ise 185.6-159.5 18,792 x 114,841 159.5 133,633 Sale November 2006 - sell (1,500) (25,000) (33,408) Remaining 4,500 £ 75,000 £ 100,225
£ Gain: Proceeds 45,000 Less: cost (25,000) Less: indexation (33,408 – 25,000) (8,408) Gain £11,592
Shar es and Secur it ies: Mat ching Rules 221
Answer 2
1982 Holding 25.9.2006 12 May 1974 2,000 13 June 1975 3,000 14 July 1976 5,000 25 September 2006 _____ 1,000 10,000 1,000 Sell (28.9.06) (2,000) (1,000) Remaining 8,000 Nil
Disposal 1 – 1,000 shar es acquir ed 25.9.06 (pr evious 9 days)
Proceeds £ 1000 18,000 x 3000 6,000 Less: cost (25.9.06) (6,500) Loss (500)
Disposal 2 – 2,000 shar es f r om 1982 holding
1982 Holding: Shar es Cost 82 MV
May 1974 2,000 6,000 June 1975 3,000 9,000 July 1976 5,000 10,000 10,000 25,000 20,000 Sale (28.9.06) (2,000) (5,000) (4,000) Remaining 8,000 20,000 16,000
Cost 82MV Proceeds £ £ 2000 £ 18,000 x 3000 12,000 12,000 Less: cost (5,000) Less: 1982 value (4,000) Less: indexat ion 185.2-79.44 (6,655) (6,655) (1.331) x £ 5,000 79.44 I ndexed gain £ 345 £ 1,345
Take lower gain £ 345
Summar y of Gains: £ 1,000 shar es Previous 9 days (500) 2,000 shar es 1982 holding 345 3,000 ____ Net loss £ (155)
222 Principles of Business Taxat ion ‘Finance Act 2006’
SUMMARY – SHARES AND SECURITIES: MATCHING RULES
When shares that have been bought in tranches over t ime ar e sold, we use mat ching r ules t o ident if y which shar es ar e being sold.
The mat ching r ules f or companies ar e: 1st Shar es acquir ed on same day 2nd Shar es acquir ed in pr evious 9 days 3r d Shar es acquir ed bet ween 1 Apr il 1982 and 10 days bef or e disposal (“FA 1985 pool”) 4t h Shar es acquir ed bet ween 6 Apr il 1965 and 31 March 1982 (“1982 pool”) 5th Shares acquired bef ore 6 April 1965
Ther e is a dif f er ent r ule (2) wher e t he selling company holds 2% or mor e of t he shar es, and shar es have been bought in t he mont h bef or e or t he mont h af t er t he disposal.
Once t he disposals have been mat ched wit h t he acquisit ions, a gain is calculat ed f or each mat ch.
The “1985 pool” gr oups t oget her shar es bought af t er Apr il 1982 and t r eat s t hem as a single asset . The pool wor king has t hr ee columns being t he number of shar es, t he cost and t he indexed cost .
Each acquisit ion is ent er ed int o t he pool and we index bet ween oper at ive event s (being acquisit ions and disposals) as we go along wit hout r ounding t he indexat ion f act or . Finally, t he appr opr iat e pr opor t ions of t he pooled cost and indexed cost ar e used in calculat ing t he gain based on t he number of shar es sold t hat wer e mat ched wit h t his pool.
The “1982 holding” or “1982 pool” gr oups t oget her shar es bought bef or e Apr il 1982 and t r eat s t hem as a single asset . The pool wor king has t hr ee columns being t he number of shar es, t he cost and t he 1982 value.
The appr opr iat e pr opor t ions of t he pooled cost and 1982 value ar e used in calculat ing t he gain, based on t he number of shar es sold t hat wer e mat ched wit h t his pool.
I ndexat ion can be calculat ed in one st ep based on t he higher of t he cost / MV82 of t he shar es being sold.
Disposals of subst ant ial shar eholdings ar e exempt f r om t ax. “Subst ant ial” means 10% or mor e of t he shar e capit al.
C16: SUBSTANTIAL SHAREHOLDING EXEMPTION
I n t his chapt er you will look at t he exempt ion t hat applies t o subst ant ial shar eholdings held by companies in mor e det ail, including: - t he def init ion of “subst ant ial” f or t hese pur poses; - t he 12 mont h per iod dur ing which t he holding must have been subst ant ial; - t he condit ions f or t he invest ing company; - t he condit ions f or t he invest ee company; - t he int er act ion of t hese r ules wit h ot her ar eas including t he gr oup r ules.
C16.1 Introduction
Gains ar ising on disposals of qualif ying shar eholdings are exempt and losses are not allowable.
Ot her EU count r ies oper at e similar syst ems – Aust r ia, Belgium, Denmar k, Ger many, Luxembour g, t he Net her lands, Por t ugal and Spain cur r ent ly exempt gains on all or some classes of subst ant ial shar eholding.
C16.2 Outline of the relief Sch 7AC TCGA 1992 Gains ar e not char geable and losses ar e not allowable wher e: (i) an invest ing company; (ii) which has held a subst ant ial shar eholding in an invest ee company (ref erred t o by Sch 7AC TCGA 1992 as ‘t he company invest ed in’) t hr oughout a 12-mont h per iod; (iii) disposes of any shar es in t he invest ee company.
Ther e is no r equir ement f or t he pr oceeds f r om t he sale of t his shar eholding t o be used in any par t icular way.
C16.3 The substantial shareholding requirement
The exempt ion is dependent on t he invest ing company having held a subst ant ial Par a 7 shar eholding in t he invest ee company t hr oughout a 12-mont h per iod beginning no Sch 7AC TCGA 1992 mor e t han t wo year s pr ior t o t he disposal.
The invest ing company must hold at least 10% of t he or dinar y shar e capit al of Par a 8 t he invest ee company and must also be benef icially ent it led t o at least 10% of : Sch 7AC TCGA 1992
(i) t he pr of it s available f or dist r ibut ion t o equit y holder s; and (ii) t he asset s available f or dist r ibut ion t o equit y holder s on a winding up.
224 Principles of Business Taxat ion ‘Finance Act 2006’
The def init ion of ‘equit y holder ’ and t he det er minat ion of pr of it s or asset s available f or dist r ibut ion br oadly f ollow t he approach in Sch 18 I CTA 1988.
The pur pose of t he t ime limit r ef er r ed t o above is t o allow subsequent disposals out of what was once a subst ant ial shar eholding t o cont inue t o qualif y f or exempt ion f or a f ur t her 12 mont hs, not wit hst anding t he f act t hat t he 10% t hr eshold may have ceased t o be sat isf ied.
Illustration 1
Vaughan Lt d has owned 15% of Key Tr ading Lt d since 1998.
On 1 J une 2006, Vaughan Lt d sold a 10% st ake in t he company at a pr of it . The gain on t his disposal clear ly qualif ies f or t he subst ant ial shar eholding exempt ion. However , some mont hs lat er , t he dir ect ors of Vaughan Lt d ar e consider ing t he possibilit y of selling t he r emaining 5% shar eholding.
Even t hough t he shar es in Key Tr ading Lt d no longer const it ut e a subst ant ial shar eholding, t he exempt ion is st ill available f or disposals in t he 12 mont hs f ollowing 1 J une 2006. Thus, if t he second sale is also expect ed t o r ealise a gain, it will be sensible for Vaughan Ltd to effect the disposal on or before 1 June 2007. However , if t he value of Key Tr ading Lt d has r ecent ly declined such t hat a shar e sale would now cr yst allise a loss, t he company should wait unt il af t er 1 J une 2007 so t hat t he loss will be allowable.
I f a gr oup’s shar eholding in t he invest ee company is split bet ween var ious gr oup Par a 9 Sch 7AC member s, t he shar es can be aggr egat ed in or der t o det er mine whet her t he TCGA 1992
subst ant ial shar eholding r equir ement is sat isf ied. For t he pur poses of t hese r ules, a gr oup compr ises a pr incipal company and it s 51% subsidiar ies – not e t hat t he s.170 TCGA 1992 def init ion of a gr oup is used, t he only dif f er ence being t he Par a 26 Sch 7AC subst it ut ion of ‘51%’ f or ‘75%’. TCGA 1992
Illustration 2
Gough Ltd
60%
5% Giles Ltd
7% St ewar t Lt d
Subst ant ial Shareholding Exempt ion 225
I n t his diagr am, Gough Lt d does have a subst ant ial shar eholding in St ewar t Lt d (5% + 7% = 12%). Because Gough Lt d cont r ols Giles Lt d t he shar es in Giles Lt d ar e t r eat ed as t hough t hey ar e held by Gough Lt d. Not e t hat t her e is no need t o wor k out an indir ect int er est .
C16.4 Liquidations
When a company goes int o liquidat ion, it loses benef icial owner ship of it s asset s Par a 16 as a r esult of t hose asset s being vest ed in t he liquidat or . However , t he r ules Sch 7AC TCGA 1992 pr ot ect an invest ing company f r om t his out come as f ar as t he subst ant ial shar eholding r ules ar e concer ned so t hat it can cont inue t o sat isf y t he necessar y condit ions f or exempt ion.
Par a 18 Sch 7AC C16.5 Conditions for the investing company TCGA 1992
The invest ing company must be eit her : (i) a ‘sole t r ading company’; or (ii) a member of a ‘t r ading gr oup’ beginning wit h t he st ar t of t he lat est 12-mont h per iod in r elat ion t o which it passed t he subst ant ial shar eholding t est and ending wit h t he t ime of t he disposal.
I t must also be a sole t r ading company or a member of a t r ading gr oup immediat ely af t er t he disposal.
A sole t r ading company means any t r ading company which is not a member of a gr oup. ‘Tr ading company’ and ‘t r ading group’ ar e def ined in much t he same way as t hey ar e f or business asset t aper r elief pur poses.
Illustration 3
Poult er Lt d acquir ed 2,500 or dinar y shar es in Rose Lt d on 30 April 2001. This r epr esent ed a 25% st ake.
On 30 April 2006 Poulter Ltd sold 2,000 of t hese shar es and 11 mont hs lat er on 31 Mar ch 2007 t he r emaining 500 wer e disposed of .
I n r espect of t he sale on 30 Apr il 2006, Poult er Lt d must be a t r ading company or a member of a t r ading gr oup f or 12 mont hs f r om 1 May 2005 unt il 30 April 2006.
However , f or t he sale on 31 Mar ch 2007, t he qualif ying per iod r uns f or 23 mont hs f rom 1 May 2005 unt il 31 March 2007.
226 Principles of Business Taxat ion ‘Finance Act 2006’
C16.6 Conditions for the investee company Par a 19 Sch 7AC TCGA 1992 The invest ee company must have been a t r ading company or t he holding company of a t r ading gr oup t hr oughout t he per iod r ef er r ed t o in I llust r at ion 3.
I t must also be a t r ading company or t he holding company of a t r ading gr oup immediat ely af t er t he disposal.
However , wher e t he invest ee company ceases t o t r ade on being put int o Par a 3 liquidat ion or f ollowing an int r a-gr oup t r ansf er of it s t r ade (so t hat it would no Sch 7AC TCGA 1992 longer sat isf y t he t est above), a special r ule means any gain accr uing t o t he invest ing company on a disposal of shar es in t he invest ee company t o cont inue t o be exempt f or a f ur t her t wo-year per iod. This is of t en called t he second subsidiar y exempt ion.
C16.7 Holdover relief
Wher e a gif t of shar es is made t o a company and holdover r elief is claimed under Par a 37 s.165 TCGA 1992, it is not possible f or t he company subsequent ly t o dispose of Sch 7AC TCGA 1992 t hose shar es wit h t he benef it of t he subst ant ial shar eholding exempt ion. An amount equal t o t he held over gain will st ill be char geable.
C16.8 Investments in non-UK resident companies
The subst ant ial shar eholding exempt ion is not r est r ict ed t o disposals of shar es in UK-based companies. Gains ar ising on t he sale of non-UK r esident subsidiar ies and ot her invest ment s ar e also cover ed.
C16.9 Intra-group transfers
The subst ant ial shar eholding exempt ion does not apply t o s.171 t r ansf er s wit hin a Par a 6 capit al gains t ax gr oup. Ef f ect ively t he s.171 pr ovisions over r ide t he subst ant ial Sch 7AC TCGA 1992 shar eholding r ules wher e shar es in t rading companies ar e t r ansf er r ed bet ween gr oup companies.
When an invest ing company acquir es shar es under a s.171 t r ansf er and Par a 10 subsequent ly disposes of t hose shar es t o an unr elat ed company, t he holding Sch 7AC TCGA 1992 per iod is ext ended t o include t he per iod f or which t he t r ansf er or held t hose shar es (and any per iod f or which t he t ransf er or was t r eat ed as holding t hose shar es as a r esult of t he same pr ovisions).
C16.10 Degrouping charge
Wher e a degr ouping char ge ar ises under s.179 TCGA 1992 in r elat ion t o a holding Par a 38 of shar es t hat , at t he t ime of t he company leaves t he gr oup, would qualif y f or Sch 7AC TCGA 1992 t he subst ant ial shar eholding exempt ion on an act ual disposal of t he shar es, t he subst ant ial shar eholding r ules ef f ectively over r ide t he s.179 pr ovisions.
Subst ant ial Shareholding Exempt ion 227
SUMMARY – SUBSTANTIAL SHAREHOLDINGS EXEMPTION
Fr om 1 Apr il 2002 gains on shar es held by companies ar e exempt f r om cor por at ion t ax pr ovided t hat at least a 10% st ake has been held for 12 out of the last 24 mont hs of owner ship.
Bot h companies must be t r ading companies (or member s of a t r ading gr oup) as def ined f or t aper r elief pur poses t hr oughout t he 12 mont h holding per iod AND immediat ely af t er t he disposal.
Losses on t he sale of a “subst ant ial shareholding” ar e not allowable and negligible value claims made on or af t er 1 Apr il 2002 cannot be backdat ed t o t r igger a loss.
Subst ant ial shar eholdings ar e t r ansf er r ed wit hin a capit al gains group on a no gain/ no loss basis. Owner ship per iods of all gr oup companies ar e aggr egat ed t o det er mine whet her t he condit ions have been sat isf ied.
Wher e a company leaves a gr oup t aking a “subst ant ial shar eholding” wit h it a degr ouping char ge under s.179 will not ar ise. The base cost of t he shar es will become t he mar ket value at t he t ime of leaving t he gr oup.
C17: THE PRINCIPLES OF GROUP RELIEF
This session will consider t he r elief t hat is available t o a gr oup of companies wher e one of t hem makes a t r ading loss. I n part icular it will look at : - how a gr oup is const it ut ed; - t he r at es at which a loss can be r elieved; - how a company will decide wher e t he loss should be r elieved bear ing in mind t he amount of t ax saved; - the timing of the relief.
C17.1 Introduction
Group r elief allows losses t o be t r ansf er r ed t o pr of it making companies in t he same 75% group.
Illustration 1
A Lt d £ 100,000
75%
B Lt d (£ 60,000)
Under t he gr oup r elief pr ovisions, we can sur r ender t he loss of £ 60,000 f r om B t o A r educing A' s t axable pr of it and it s cor por at ion t ax liabilit y.
The maximum claim is t he lower of t he available loss or the available profit.
Illustration 2 A Lt d (£ 100,000)
75%
B Lt d £ 60,000
The Principles of Group Relief 229
The gr oup r elief claim her e will be a maximum of £ 60,000. A Lt d will have t he r emaining loss of £ 40,000 which it may be able t o set of f in t he cur r ent year , car r y back, or car r y f or war d. Losses t hat ar e unut ilised can only be car r ied f or war d in t he company t hat or iginally sust ained t hem.
C17.2 The 75% definition s.413 Sch 18 I CTA 1988 For group relief t o apply, one company must own at least 75% of the other. For example if A Limit ed owns 75% of B Limit ed, t hat means t hat losses can f low f r om A t o B or f r om B t o A.
Not e t hat t he pr ovisions only apply to company ownership, theref ore, if Mr A owned 75% of B Limit ed, losses could not f low bet ween Mr A and B Limit ed, as Mr A pays I ncome Tax and B Limit ed pays Cor por at ion Tax.
Group r elief also applies between two companies t hat are each owned to t he ext ent of 75% by the same parent company.
Par ent Lt d
75% 75%
Sub 1 Lt d Sub 2 Lt d
Losses can flow bet ween t he par ent and t he t wo subsidiar ies in either direction and losses can also f low bet ween t he t wo subsidiar ies.
I f t he t wo subsidiar ies ar e owned by Mr P inst ead of Par ent Lt d, losses could not f low eit her bet ween Mr P and t he t wo companies, or indeed bet ween t he t wo subsidiar ies. Cor por at e owner ship must apply f or gr oup r elief of losses.
The 75% test applies t o all t hr ee of t he f ollowing:
(i) Ther e must be 75% ownership of ordinary share capital of the company; and
(ii) Those shar es must ent it le t he shar eholder s t o at least 75% of t he available distributable profits; and
(iii) Those shar es must ent it le t he shar eholder t o at least 75% of t he company’s assets on a winding up.
These t hr ee t oget her f or m t he def init ion of “equitable ownership”.
230 Principles of Business Taxat ion ‘Finance Act 2006’
Illustration 3
Par ent Co
80% 90%
A Ltd C Lt d
90% 90%
B Lt d D Lt d
I n t he above scenar io, Par ent Co and A Lt d ar e in a 75% gr oup.
However t o det er mine whet her Par ent Co and B Lt d ar e in t he same gr oup r elief gr oup, we mult iply 80% and 90% t o give 72%. This is less t han 75% so a gr oup is not f or med. I f B Lt d has a loss, it cannot sur r ender it t o Par ent Co. or vice ver sa. B Lt d and A Lt d ar e in a 75% so t r ading losses can be sur r ender ed bet ween t hem.
Cont r ast t his wit h t he r elat ionship bet ween Par ent Co and C Lt d and D Lt d. I n t his inst ance t he 3 companies ar e in a group relief group as Parent Co’s ef f ect ive int er est in D Lt d is 81% (i.e. 90% x 90%).
The gr oup r elief gr oups ar e t her ef or e:
Par ent Co + A Lt d + C Lt d + D Lt d and A Ltd + B Ltd
I t can be seen, t her ef or e, t hat a company can par t icipat e in mor e t han one gr oup r elief gr oup.
Not e t hat all 5 companies ar e associat ed wit h each ot her so t he cor por at ion t ax limit s f or each of t he companies ar e divided by 5.
C17.3 Available amounts
The sur r ender ing company (i.e. t he loss making company) may sur r ender : s.403 I CTA 1988 (i) t r ading losses (ii) DI I I losses
The t ot al amount of t hese losses may be sur r ender ed bef or e t he sur r ender ing company is r equir ed t o consider any loss of f set in it s own comput at ion.
Fur t her mor e t he sur r ender ing company may also sur r ender (iii) excess management expenses (iv) excess Schedule A losses
The Principles of Group Relief 231
(v) excess DVI losses on non t r ade I FAs (vi) excess char ges (t r ade and non-t r ade)
The amount of “excess” available f or gr oup r elief is f ound by compar ing gr oss income bef or e any loss set of f s t o char ges, management expenses, Schedule A losses and DVI losses on I FAs as appr opr iat e.
The sur r ender ing company sur r ender s t o t he claimant company (i.e. t he pr of it making company) who must set the losses against profits chargeable to corporation tax.
The claimant company must set t he losses against pr of it s char geable t o cor por at ion t ax in t he same account ing per iod.
The claimant company must use the losses in its current accounting period – any losses claimed under gr oup r elief cannot be carried back, carried f orward or given t o anot her gr oup member .
The of f set against PCTCT will be made af t er char ges and any cur r ent year or br ought f or war d losses. However t he of f set is made bef or e losses br ought back f rom a f ut ure period i.e. losses carried back do not displace group relief already claimed.
Illustration 4
Two 75% gr oup companies have t he f ollowing r esult s:
Claimt on Lt d Sur r t on Lt d £ £ Schedule D Case I (6,000) (80,000) Schedule D Case III 20,000 (4,000) Schedule A - 10,000 Char ges on income (1,000) -
The available loss of Sur rt on Lt d is as f ollows: Sur r t on Lt d
£ Schedule D Case I (80,000)
Schedule D Case III (4,000) Available loss (84,000)
232 Principles of Business Taxat ion ‘Finance Act 2006’
The available pr of it of Claimt on Lt d is as f ollows:
Claimt on Lt d Sur r t on Lt d
£ £ Schedule D Case I Nil (80,000) Schedule D Case III 20,000 (4,000)
Cur r ent Year Loss (6,000) 14,000 Char ges on income (1,000) ______
13,000 (84,000) Group r elief f r om Sur r t on Lt d – lower of PCTCT or loss (13,000) 13,000 available (71,000) Cur r ent year claim in Sur r t on (if made) 10,000 ______
Remaining loss £ (61,000)
C17.4 Effective use of losses
When using losses, it is impor t ant t o obt ain r elief at t he highest mar ginal r at es of t ax and secondly t o use t he losses up sooner r at her t han lat er .
Fr om a t iming per spect ive our pr ef er ence would be f or claims in t he f ollowing order:
(i) current year and t hen carry back; (ii) group relief; (iii) carry forward.
However , t he pr imar y obj ect ive f or t he companies is t o save t he maximum t ax possible on a gr oup wide basis. To appr eciat e how t his is done, we must consider t he ef f ect ive marginal rates of t ax of all of t he companies in t he gr oup.
C17.5 Marginal rates of tax
We have various marginal rates of tax, depending on t he level of t he company’s not ional pr of it .
The Principles of Group Relief 233
By “mar ginal” r at e we mean t he r at e of cor por at ion t ax ef f ect ively payable on t he f inal £ 1 of a company’s PCTCT.
Tax r at es: FY 2006 FY 2002 t o 2005
£0 - £ 10,000 19% 0% £ 10,001 - £ 50,000 19% 23.75% £ 50,001 - £ 300,000 19% 19% £ 300,001 - £ 1,500,000 32.75% 32.75% > £ 1,500,000 30% 30%
The limits would obviously be divided amongst the number of associates in the group.
The mar ginal r at es of 23.75% and 32.75% ar e calculat ed as f ollows:
23.75% rat e: £ £ 50,000 x 19% 9,500 (10,000) x 0% - 40,000 9,500 9500 = 23.75% 40000
32.75% rat e: £ £ 1,500,000 X 30% 450,000 (300,000) X 19% (57,000) 1,200,000 393,000 393000 = 32.75% 1200000
Illustration 5
Hill Lt d owns 100% of t he shar es of Collis Lt d. As t he companies ar e associat ed, t he cor por at ion t ax limit s (FY 2005) will be as f ollows:
£ Starting rate limit 5,000 Lower r at e limit 25,000 Small companies limit 150,000 Upper limit 750,000
Assuming Hill Lt d has PCTCT of £ 1m it will be a “lar ge” company and will pay cor por at ion t ax at t he f ull r at e of 30%, i.e.
£ 1,000,000 x 30% = £ 300,000
234 Principles of Business Taxat ion ‘Finance Act 2006’
Anot her way t o ar r ive at t his CT liabilit y is t o consider t he mar ginal t ax r at es which apply wit hin each of t he 5 t ax bands:
£ First £ 5,000 @ 0% - Next £20,000 @ 23.75% 4,750 Next £125,000 @ 19% 23,750 Next £600,000 @ 32.75% 196,500 Remaining £ 250,000 @ 30% 75,000 Tot al t ax on PCTCT of £ 1m £ 300,000
Diagr amat ically t hese mar ginal r at es can be illust r at ed as below:
30%
£ 1,500,000 32.75%
£ 300,000 19%
£ 50,000
23.75%
£ 10,000
0%
Prof it s
Prof it s Divided by number of associat es as appr opr iat e
This diagr am illust r at es t hat if a company had pr of it s bet ween t he upper limit and t he small companies limit s (i.e. bet ween £ 300,000 and £ 1,500,000 in t his example), and it wer e given an extra £1 of income it would pay cor por at ion t ax at a r at e of 32.75% on t hat “mar ginal” £ 1.
This 32.75% r at e is an ef f ect ive marginal r at e and should not be used when calculat ing MCT liabilit ies.
Ther ef or e when making gr oup r elief claims, we will t r y t o eliminat e pr of it s t axed at t he highest mar ginal r at e, i.e. 32.75%.
The Principles of Group Relief 235
To achieve t his we need t o specify t he amount of gr oup r elief r equir ed in or der t o br ing t he pr of it down t o t he exact level of t he small companies limit . This ensur es t hat all of t he loss will be r elieved at an ef f ect ive r at e of 32.75%. As gr oup r elief claims can be specif ied, t his is ver y easy t o do.
We would t hen st ar t er oding pr of it s t axed at 30%, t hen pr of it s t axed at 23.75%, again specif ying t he claim t o r educe t he pr of it down t o t he st ar t ing r at e lower limit and no f ur t her . Next we er ode pr of it s t axed at 19%, we should avoid eliminat ing pr of it t hat is t axed at 0%
Illustration 6
X Lt d is a par ent company wit h t wo wholly-owned subsidiar ies Y Lt d and Z Lt d.
The r esult s in t he year ending 31 Mar ch 2007 ar e as f ollows:
X Lt d Y Lt d Z Ltd £ £ £ Schedule D Case I 600,000 (40,000) (20,000) Schedule D Case III 50,000 121,000 10,000
I n or der t o calculat e t he opt imum loss r elief we need t o car r y out t he f ollowing st eps.
Fir st we build up t he cor por at ion t ax comput at ions so t hat we can wor k out what r at es of t ax t he pr of it s ar e being char ged at .
X Ltd Y Lt d Z Ltd £ £ £ Schedule D Case I 600,000 Nil Nil Schedule D Case III 50,000 121,000 10,000 Profit 650,000 121,000 10,000
Next we need t o calculat e t he upper and lower limit s:
£ 300000 £ 10000 Limit s = £ 100,000 = £ 3,333 3 3
£ 1.5m £ 50000 = £ 500,000 = £ 16,667 3 3
We can see t hat X is paying t ax at 30%, Y is paying t ax at 32.75% on t he t op par t of it s pr of it s and Z is paying t ax at 23.75%.
We want t o save t ax at t he highest mar ginal r at e.
236 Principles of Business Taxat ion ‘Finance Act 2006’
Y has a loss of £ 40,000. The opt imum claim will be t o use £ 21,000 of loss t o r educe Y’s pr of it s down t o t he lower limit and t hen t o use t he balance of t he loss in X by way of gr oup r elief .
Z has a loss of £ 20,000 and t he best place t o use t his loss will again be in X by way of gr oup r elief .
Ther ef or e, in Y, as we cannot specif y t he amount t o of f set under a cur r ent year claim (it is an all or not hing claim), t he gr oup r elief claim of £ 19,000 must be made f ir st bef or e submit t ing an all-or -not hing cur r ent year claim under s.393A(1)(a) f or t he balance, being £ 21,000.
X Ltd Y Lt d Z Ltd £ £ £ Schedule D Case I 600,000 Nil Nil Schedule D Case III 50,000 121,000 10,000 Profit 650,000 121,000 10,000 Current year claim (21,000) Group relief: Y Ltd (19,000) Z Ltd (20,000) ______PCTCT £611,000 100,000 10,000
Example 1
Consider t he f ollowing:
Fog Lt d Mist Ltd £ £ Schedule D Case I 80,000 10,000 Schedule A - (100,000) Char ges on income (5,000) -
What is t he maximum loss t hat can be sur r ender ed f r om Mist Lt d t o Fog Lt d?
Example 2
Consider t he gr oup below: Mr Wootten Hayward Ltd 100% 76% 24%
Seaford Ltd Brighton Ltd 80% 51%
Hove Lt d East bour ne Ltd
100% Wort hing Ltd
60% Hast ings Ltd
The Principles of Group Relief 237
You ar e r equir ed t o:
(1) Ident if y t he companies which ar e associat ed wit h Seaf or d Lt d f or cor por at ion t ax pur poses.
(2) I dent if y t he gr oups which exist f or gr oup r elief pur poses.
Example 3
Houllier Lt d has t wo wholly owned subsidiar ies Owen Lt d and Heskey Lt d, and 60% of t he shar es in Ger r ar d Lt d. The r esult s f or t he year ended 31 Mar ch 2006 ar e as f ollows:
Houllier Lt d Owen Lt d Heskey Lt d Ger r ar d Lt d £ £ £ £
Schedule DI 100,000 40,000 nil 90,000 Trading loss (60,000) Schedule DIII 10,000 4,000 6,000 2,000 Chargeable gain 20,000 - - 4,000
You ar e r equir ed t o calculat e t he cor por at ion t ax liabilit y f or each company, assuming t he loss r elief is t aken in t he most ef f icient way.
238 Principles of Business Taxat ion ‘Finance Act 2006’
Answer 1
Fog Ltd Mist Ltd £ £ Schedule D Case I 80,000 10,000 Schedule A (10,000) Char ge on income (5,000) ___ Prof it 75,000 Nil Group relief (75,000) PCTCT Nil
The excess Schedule A loss is £ 90,000 of which £ 75,000 can be sur r ender ed. The r emaining £ 15,000 will be carried f orward.
Answer 2
(1) Associat ed companies:
Seaf or d Lt d Hove Lt d Limit s f or corporat ion East bourne Lt d t ax are t heref ore Wort hing Lt d divided by 6 Hast ings Lt d Br ight on Lt d
Seaf or d Lt d is associat ed wit h Br ight on Lt d as t hey ar e cont r olled by t he same per son – i.e. Mr Woot t en.
To det er mine whet her Seaf or d Lt d and Hast ings Lt d ar e associat ed, we do not mult iply t he ef f ect ive int er est s – it is suf f icient t hat each company in t he chain is cont r olled by it s par ent .
(2) Group r elief gr oup:
Ther e is only one gr oup f or gr oup r elief pur poses, i.e.
Seaf or d Lt d + Hove Lt d + Wor t hing Lt d.
Seaf or d Lt d and Br ight on Lt d ar e not in t he same gr oup as t hey ar e not under t he 75% cont r ol of t he same company.
The Principles of Group Relief 239
Answer 3
Small companies limit s – 4 company gr oup £10,000 x ¼ £2,500 £50,000 x ¼ £12,500 £300,000 x ¼ £75,000 £1.5m x ¼ £375,000
Houllier Ltd Owen Lt d Heskey Lt d Ger r ar d Lt d £ £ £ £ Schedule DI 100,000 40,000 - 90,000 Schedule DIII 10,000 4,000 6,000 2,000 Char geable gain 20,000 ______4,000 PCTCT bef or e loss r elief 130,000 44,000 6,000 96,000
Tax rate prior to relief Mar ginal 19% Small Mar ginal mar ginal Current year (3,500) Group relief (55,000) (1,500) _____ n/a PCTCT af t er gr oup r elief 75,000 42,500 2,500 96,000
CT @ 19% 14,250 8,075 - CT @ 30% 28,800 11/ 400 x (375,000 – 96,000) ( 7,673) ______CT payable 14,250 8,075 - 21,127 Not es: 1 Ger r ar d Lt d is not a 75 % subsidiar y and so cannot par t icipat e in t he gr oup r elief claim (it is however an associat e) 2 Houllier Lt d’s pr of it s ar e in t he highest mar ginal band – i.e. 32.75%. Ther ef or e we f ir st use suf f icient losses t o br ing Houllier Lt d’s pr of it s down t o t he small companies limit of £ 75,000. 3 Heskey’s Lt d’s pr of it s ar e in t he lower mar ginal band – i.e. 23.75%. Ther ef or e we have used suf f icient losses t o br ing Heskey Lt d’s pr of it s down to the starting rate limit of £ 2,500. 4 I t would have been equally correct to allocat e t he £ 1,500 balance of losses t o Houllier Lt d inst ead of Owen Lt d, as it saves 19% t ax in bot h cases, and in f act would save administ r at ive wor k as a signat or y f or each company has t o sign a gr oup r elief claim. 5 The or der of claims will be as f ollows: £ Loss in Heskey Lt d 60,000 Less: gr oup r elief in Houllier Lt d (55,000) Less: gr oup r elief t o Owen Lt d (1,500) Balance 3,500 Less: s.393(A)(1)(a) cur r ent year Claim in Heskey Lt d (3,500) Loss r emaining Nil
240 Principles of Business Taxat ion ‘Finance Act 2006’
SUMMARY – THE PRINCIPLES OF GROUP RELIEF
When a company makes a t r ading loss it can sur r ender it t o anot her member of t he same 75% gr oup.
The maximum amount t hat can be sur r ender ed is t he lower of :
(i) t he loss of t he sur r ender ing company, and
(ii) t he PCTCT of t he claimant company
Ther e is no r equir ement f or t he sur r ender ing company t o use t he loss against it s own income bef or e sur r ender but it may do if it so chooses.
Schedule DI I I def icit s may also be gr oup r elieved in t he same way.
Excess Schedule A losses, excess char ges (t r ade or non t r ade), excess management expenses and excess DVI losses on non t r ade I FAs can also be included in a group r elief claim.
The loss is allocat ed t o r elieve income t axed at t he highest (mar ginal) r at es.
The mar ginal r at es ar e:
£ 0 - £ 10,000 0% £ 10,001 - £ 50,000 23.75% £ 50,001 - £ 300,000 19% £ 300,001 - £ 1,500,000 32.75% over £ 1.5m 30%
C18: GROUP CAPITAL GAINS
This chapt er cover s t he def init ion of a gains gr oup and looks at how it dif f er s f r om a losses gr oup. Once we have est ablished t he gr oup we will t hen consider : - t he ef f ect of t r ansf er r ing asset s bet ween gr oup companies; - t he loss relief which is available; - t he availabilit y of r ollover r elief in a gains gr oup; - t he t r ansf er of asset s t o st ock wit hin a gr oup.
C18.1 Definition
Companies ar e in t he same capit al gains gr oup when one company owns at least s. 170 of t he or dinar y shar es of anot her company or t wo companies ar e 75% 75% TCGA 1992 owned by t he same par ent .
This 75% def init ion is similar t o t he rules f or gr oup r elief but , f or gr oup gains pur poses, we only need 75% of the ordinary shares and not 75% of dist r ibut able pr of it s nor 75% of asset s on a winding-up.
The gr oup gains r egime also has slight ly dif f er ent r ules f or sub-subsidiar ies.
For gr oup gains, t he dir ect r elat ionship must be at least 75% but the indirect s. 170(3) TCGA 1992 relationship need only be above 50%. We r ef er t o t his as t he ef f ect ive 51% subsidiar y t est .
I n addit ion, f or gr oup gains a company can only be a member of one gr oup. s. 170(6) TCGA 1992
242 Principles of Business Taxat ion ‘Finance Act 2006’
Illustration 1
Consider t he f ollowing st r uct ur e:
A Ltd
75%
B Lt d
75%
C Lt d
75%
D Lt d
75%
E Lt d Group relief group:
For gr oup loss r elief we need a 75% direct and indirect relationship.
Ther ef or e, f or gr oup r elief we can t r ansf er losses bet ween A and B, bet ween B and C, bet ween C and D and bet ween D and E.
The indir ect r elat ionship bet ween A and C is 56.25%. For gr oup r elief we need at least 75%; no losses can f low bet ween A and C nor bet ween A and any ot her companies f ur t her down t he gr oup.
Group gains group:
When consider ing a capit al gains gr oup we must look at t he A gr oup as A is t he ult imat e holding company. Thus we call A t he pr incipal company. A owns 56.25% of C and, consequent ly, C can be included in A' s gains gr oup.
However , A only owns 42% of D (75% of 56.25%), and t her ef or e as t his is below 50%, D is not par t of A' s gr oup. Consequent ly, t he A capit al gains gr oup compr ises companies A, B and C.
Group Capit al Gains 243
We cannot link C and D f or t he gr oup gains pur poses - t he r eason f or t his is t hat a company which is a 75 % subsidiar y of anot her company cannot be a pr incipal company unless it f ails t he ef f ect ive subsidiar y t est . I n ot her wor ds a company cannot be a member of mor e t han one gr oup f or gr oup gains pur poses.
As C is a member of A's gains group, it cannot form a sub-group with D. This r ule does not apply t o gr oup r elief so f or gr oup r elief we can link C and D, but f or gr oup gains we cannot .
However , D can be a pr incipal company and f or m it s own gr oup and, consequent ly, we can link D and E t oget her f or gr oup gains pur poses as D becomes a new holding company. So, f or gr oup gains, we have t wo gr oups, t he A gr oup compr ising A, B and C, and t he D gr oup compr ising D and E.
Transfers of assets:
C and D ar e clear ly connect ed companies and consequent ly any t r ansf er s bet ween t hese companies will be at mar ket value.
Transfers of assets wit hin t he same capital gains group however will all t ake s. 171 TCGA 1992 place at no gain no loss - we shall st udy t his in mor e det ail shor t ly.
Example 1
Consider t he f ollowing st r uct ur e:
A Ltd
90%
B Lt d
90%
C Lt d
90%
D Lt d
90%
E Lt d
I dent if y which companies ar e in A’s gr oup r elief gr oup and capit al gains gr oup.
244 Principles of Business Taxat ion ‘Finance Act 2006’
C18.2 Intra group transfers of assets s.171 TCGA 1992
Transfers bet ween members of the same group ar e t r eat ed as no gain no loss transfers. This r ule applies aut omat ically and is compulsor y. This is t he same r ule t hat applies t o t r ansf er s of asset s bet ween a mar r ied couple.
The r ules apply wher e:
a) t he t r ansf er r ing company is UK r esident at t he t ime of t he disposal or t he asset is a char geable asset in r elat ion t o t he company immediat ely bef or e t hat t ime and b) t he t r ansf er ee company is eit her UK r esident at t he t ime of t he disposal or t he asset is a char geable asset in r elat ion t o t hat company immediat ely af t er t hat t ime.
Illustration 2
Beckham Limit ed owns 100% of Posh Limit ed. I n Sept ember 1992 Beckham Limit ed pur chased a pr oper t y at a cost of £ 500,000. I n January 2007, Beckham Limit ed decided t o t r ansf er t his pr oper t y t o Posh Limit ed. The t r ansf er will t ake place at no gain no loss.
We have a cost of £ 500,000, indexat ion of say £ 250,000 t her ef or e, our pr oceeds ar e deemed t o be £ 750,000 in or der t o give us no gain no loss.
£ Proceeds 750,000 Cost (500,000) Indexation at, say 50% (250,000) nil
I n ot her wor ds t he pr oceeds ar e cost plus indexat ion t o t he dat e of t r ansf er .
Consequently, Posh Limited will have a base cost of this particular property of £ 750,000 which it will index in a f ut ure disposal calculat ion f r om J anuar y 2007, t he dat e of t he int r a-gr oup t r ansf er .
Example 2
Thompson Lt d has one wholly owned subsidiar y, Mur phy Lt d. Mur phy bought a propert y f or £ 180,000 in July 1987. I n December 1998 it t r ansf er r ed t he pr oper t y t o Thompson Lt d when it s mar ket value was £ 250,000.
Thompson Lt d sold t he pr oper t y in August 2007 f or £ 380,000.
You ar e r equir ed t o calculat e t he gain chargeable on Thompson Ltd in its account s f or t he 12 mont hs t o 31 December 2007.
Group Capit al Gains 245
Assume (f or illust r at ion pur poses) t he f ollowing indexed r ises:
July 1987 – December 1998: 0.641 December 1998 -August 2007: 0.186
C18.3 Notional transfers s.171A TCGA 1992
A not ional t r ansf er is wher e we pretend that an asset or part of it has been transferred within the group prior to it being sold.
This is t o utilise capital losses and also t o ensur e gains are taxed at the lowest marginal rate possible.
Illustration 3
Bush Limit ed owns 100% of Blair Limit ed. They have income in t he year ended 31 March 2007 of £ 500,000 and £ 75,000 respect ively. Blair Limit ed has capit al losses br ought f or war d of £ 90,000.
I n t he year ended 31 Mar ch 2007, Bush Limit ed sold a pr oper t y and r ealised a capital gain of £150,000. What we must do is ascertain in which company it would be bet t er f or t he gain t o ar ise.
As t her e ar e t wo companies in t he gr oup, t he cor por at ion t ax lower and upper limit s must be divided by t wo giving us £ 150,000 and £ 750,000 r espect ively. The mar ginal r at es of t ax ar e 19% below £ 150,000, 32.75% bet ween t he limit s and 30% above £ 750,000.
As Bush has ot her pr of it s of £ 500,000, if we wer e t o add t he gain t o Bush' s pr of it s, t he gain would be t axed in f ull at t he mar ginal 32.75% r at e of t ax. The ext r a t ax would be:
£150,000 x 32.75% = £49,125
I f however we wer e t o do a not ional t ransf er , t r ansf er r ing t he pr oper t y f r om Bush Limit ed t o Blair Limit ed (by elect ing on t he CT600), we might f ind we get a bet t er r esult .
Blair Limit ed has ot her income of £ 75,000. We would ut ilise Blair Limit ed' s capit al losses br ought f or war d of £ 90,000 r educing t he t axable capit al gain t o £ 60,000. The gain will all be t axed at 19% so t he ext r a t ax t his t ime would be:
£(150,000 – 90,000) x 19% = £11,400
So ef f ect ing t he t r ansf er will save t he gr oup cor por at ion t ax of :
£ 49,125 - £ 11,400 = £ 37,725
Clear ly t his would be wor t hwhile.
246 Principles of Business Taxat ion ‘Finance Act 2006’
C18.4 Making a notional transfer claim s.171A TCGA 1992
The claim t o t r eat an asset or any par t of it as being t r ansf er r ed t o a f ellow gr oup company immediat ely bef or e it s sale can only be made if t he no gain no loss t r ansf er r ule would apply bet ween t he t wo companies who make t he elect ion.
I t has t o be a joint election made in writing within two years of t he end of t he s. 171A(4) account ing per iod of t he company who sells t he asset . TCGA 1992
Any incident al cost incur r ed by t he company making t he act ual disposal will be s. 171A(2) deemed t o be incident al cost of t he ot her company. TCGA 1992
Any payment s made bet ween t he companies in r elat ion t o t he not ional t r ansf er s. 171A(5) will be ignor ed t o t he ext ent t hey do not exceed t he char geable gain or allowable TCGA 1992 loss t hat ar ises on t he company making t he deemed disposal.
Example 3
Calf Limit ed is a wholly owned subsidiar y of Bull Limited. Bull Limit ed does not have any ot her subsidiar ies. Dur ing t he year ended 31 March 2007, t he pr edict ed pr of it s of each company ar e £ 100,000 and £ 700,000 r espect ively. Calf Limit ed has capit al losses br ought f orward of £ 30,000 and in Febr uar y 2007 Bull Limit ed sold a pr oper t y r ealising a capit al gain of £ 100,000.
Assuming t hat t hey ar e going t o make t he most benef icial elect ions, calculat e t he minimum cor por at ion t ax payable on t his gain.
C18.5 Group wide rollover relief
A capital gains group is treated as one unit for rollover relief purposes. s. 175 & s. 152 Assume t hat A and B ar e par t of t he same capit al gains gr oup and t hat A has TCGA 1992 sold an asset f or £ 900,000 which has r ealised a capit al gain of £ 350,000.
Remember ing t he nor mal r ules of r ollover , pr ovided t hat within one year prior to the sale and three years after, A r einvest s all of t he £ 900,000 pr oceeds, t he capit al gain can be r olled over and deduct ed f r om t he base cost of a r eplacement asset .
Assume B invest ed £ 1 million int o a new asset . This will enable t he gain in A t o be r olled over against t he base cost of t he asset pur chased by B under t he gr oup wide r ollover pr ovisions. This gives a base cost of t he r eplacement asset in B of £ 650,000.
The r ules on gr oup r ollover apply t o all companies so long as t hey ar e r esident in t he UK or car r ying on a t r ade in t he UK t hr ough a per manent est ablishment .
Group Capit al Gains 247
The r ules apply wher e a company which is a member of a gr oup disposes of an asset used in it s t r ade at a t ime when it is a member of t he gr oup, anot her company acquir es an asset at a t ime when it is a member of t he same gr oup and a j oint claim is made by t he companies.
Thus t her e is no r equir ement f or t he companies t o be member s of t he gr oup at t he same t ime. However t he company making t he disposal must be UK r esident , or t he asset must be char geable at t he t ime of t he disposal and t he company acquir ing t he asset must be UK r esident , or t he asset must be a char geable UK asset at t he t ime it is bought .
The disposal and acquisit ion of asset s by non-t r ading companies in t he gr oup can qualif y f or r ollover r elief so long as t hey ar e used in t he t r ade of ot her companies in t he gr oup.
Rollover r elief cannot be claimed f or t he acquisit ion of asset s f r om gr oup companies wher e no gain no loss r ules apply.
C18.6 Transfers within a group: trading stock s.173 TCGA 1992
Special r ules apply wher e an asset held as capit al is t r ansf er r ed t o anot her member of a capit al gains gr oup which will hold t he asset as st ock and vice ver sa.
Wher e an asset held as capital is t r ansf er r ed by company A to company B in t he same gains gr oup who will hold t he asset as trading stock, t he transfer will take place under the no gain/ no loss rules. Once B r eceives t he asset , it will be immediat ely taken to trading stock at its market value.
Illustration 4
Cap Lt d, a t r ading company, t r ansf er s a proper t y t o Hat Lt d, a pr oper t y-dealing company. The companies ar e in t he same gains gr oup. Cap Lt d had bought t he pr oper t y many year s ago f or £ 550,000. The indexat ion f act or up t o t he dat e of t r ansf er is 0.225. The mar ket value of t he pr oper t y at t he t ime of t he t r ansf er was £ 740,000
Firstly, the property will go from Cap Ltd to Hat Ltd at no gain no loss. The deemed disposal pr oceeds f or Cap Lt d will be: £ Cost 550,000 I A 0.225 x 550,000 123,750 673,750
This will also be t he base cost of t he pr oper t y f or Hat Lt d.
The asset will t hen be t aken t o st ock in Hat Lt d at it s market value of £ 740,000 and so a gain will ar ise in Hat Lt d as f ollows:
248 Principles of Business Taxat ion ‘Finance Act 2006’
Deemed pr oceeds 740,000 I ndexed cost (673,750) 66,250
I f Hat Lt d now sells t he pr oper t y f r om st ock at it s mar ket value t her e will be no t r ading pr of it .
Hat Lt d, a pr oper t y-dealing company, has t her ef or e ended up wit h a capit al gain. The company nor mally has DI income or losses f r om pr oper t y sales.
Hat Lt d can make use of t he elect ion in s.161 TCGA 1992 - t his elect ion allows a t r ader who is appr opr iat ing a capit al asset t o st ock t o elect for the asset to be taken to stock at its indexed cost. The elect ion has t o be made within two years of t he end of t he account ing per iod in which t he asset is t aken t o st ock.
I f Hat Lt d makes t his elect ion, at t he t ime of t he t r ansf er f r om Cap Lt d t he building will be t aken t o st ock at a value of £ 673,750 and t here will be no capit al gain. On a f uture sale of the property at market value, a DI prof it of £ 66,250 will ar ise.
This elect ion will be especially usef ul wher e t he pr oper t y-dealing company has t r ading losses br ought f or war d or t he t r ansf er r ed asset is st anding at a capit al loss.
I f an asset is t r ansf er r ed by a company t hat holds it as t r ading stock, to a company t hat will hold t he asset as a capital asset , t hen t he company t hat holds t he asset as t r ading st ock is t r eat ed as making a disposal from trading stock at mar ket value pr ior t o t he t r ansf er .
Illustration 5
Paper Lt d and Tr ay Lt d ar e t wo companies in a gains gr oup. Paper Lt d is a pr oper t y dealing company, Tr ay Lt d is a t r ading company. Paper Lt d has a propert y which it bought f or £ 370,000. The mar ket value of t he pr oper t y is £ 400,000. I t is to be transf erred to Tray Ltd.
Paper Lt d will be t r eat ed as t aking t he pr oper t y out of t r ading st ock at it s mar ket value and so will make a DI prof it of £ 400,000 - £ 370,000 = £ 30,000.
Tray Lt d will receive t he propert y at it s mar ket value of £ 400,000. I ndexat ion allowance will begin t o r un f r om t he dat e t he pr oper t y is t r ansf er r ed.
Group Capit al Gains 249
Answer 1
Group relief group:
Clear ly f or gr oup r elief we can t r ansf er losses bet ween A and B and bet ween B and C. A indir ect ly owns 81% of C (90% of 90%). Consequent ly, losses can also be t r ansf er r ed bet ween A and C.
A indirect ly owns 72.9% of D (90% of 81%). This is below 75% and consequent ly losses cannot f low bet ween A and D.
Ther ef or e t he gr oup r elief gr oup r elevant t o A includes companies A, B and C.
Group gains group:
For gr oup gains A indir ect ly owns 81% of C, 72.9% of D and 65.61% of E (90% of 72.9%). So, going all t he way down t he chain, we f ind t hat A' s indirect r elat ionship in E is above 50% so consequent ly all of t he companies ar e in A' s gains gr oup.
Ther ef or e t he gr oup gains gr oup r elevant to A includes companies A, B, C, D and E.
Answer 2
Tr ansf er f r om Mur phy Lt d t o Thompson Lt d in December 1998:
£ Cost t o Murphy Ltd 180,000
IA f rom July 1987 - December 1998
0.641 x £ 180,000 115,380
Cost t o Thompson Ltd 295,380
Disposal by Thompson Lt d in August 2007:
Proceeds 380,000
Less: cost December 1998 (295,380) 84,620 Less: I A Dec 1998 - August 2007
0.186 x £ 295,380 (54,941)
Gain y/e 31.12.2007 29,679
250 Principles of Business Taxat ion ‘Finance Act 2006’
Answer 3
The upper and lower limit s ar e £ 750,000 and £ 150,000 r espect ively.
Bull Lt d has ot her income of £ 700,000.
I f t he gain was t axed in Bull Lt d it would increase corporat ion t ax liabilit y by:
£ (50,000 x 32.75%) + £ (50,000 x 30%) = £ 31,375
Calf Lt d has ot her income of £ 100,000.
I f we not ionally t r ansf er t he asset t o Calf Lt d t o t r igger t he gain in Calf Lt d, t he posit ion would be impr oved as Calf has some capacit y in t he 19% band and also has capit al losses br ought f or war d. £ Gain 100,000 Capit al losses b/ f (30,000) 70,000
The corporat ion t ax liabilit y would be:
(£ 50,000 x 19% + £ 20,000 x 32.75%) = £16,050
Elect ing f or t he not ional t r ansf er has t her ef or e saved t ax of £ 15,325 f or t he gr oup.
Group Capit al Gains 251
SUMMARY – GROUP CAPITAL GAINS
A gains gr oup r equir es a 75% r elat ionship bet ween companies. However , unlike gr oup r elief gr oups it is possible t o include sub-subsidiar ies of 75% subsidiar ies, pr oviding t he ef f ect ive holding is mor e t han 50%.
Asset s t r ansf er r ed bet ween member s of a gains gr oup aut omat ically move on a no gain no loss basis, i.e. t he new company inher it s t he indexed cost of t he old one.
Companies can elect t o t r eat asset s as if t hey wer e t r ansf er r ed int r a gr oup pr ior t o sale.
Gains gr oups can claim r ollover r elief on a gr oup wide basis.
I f a f ixed asset held by one gr oup member is t r ansf er r ed t o anot her who will t ake it t o st ock t hen a gain will ar ise on t he t r ansf er ee when t he asset is appr opr iat ed t o st ock. An elect ion is however available t o allow t he asset t o be appr opr iat ed t o st ock at indexed cost .
C19: CLOSE COMPANY DEFINITION
This chapt er looks at t he f ollowing ar eas: - t he def init ion of a close company; - t he def init ion of associat e; - except ions t o being a close company.
St at ut or y r ef er ences in t his chapt er ar e t o I CTA 1988 unless st at ed ot her wise.
C19.1 Introduction
A close company is a company which is resident in the UK and is controlled by s. 414 either
• five or fewer participators (shar eholder s); or • any number of directors who are also shareholders.
Consequent ly, in t he UK, most private companies are close.
C19.2 Directors
In this context a director is anyone who act s as a dir ect or by what ever name called (e.g. Chair man). I n addit ion, we include any manager of t he company, who, wit h t heir associat es, owns 20% or mor e of t he vot ing shar es of t he company.
C19.3 Associates
When determining the level of ownership by one particular shareholder we must also include shares owned by his or her associates. The r ules f or s. 417 associat es ar e ver y similar t o t hose which apply in det er mining whet her companies ar e associat ed wit h each ot her .
Close Company Def init ion 253
For close company pur poses associat es include:
• the individual’s immediate family,
Remoter forebear
Parents
Brothers + Spouse and Sisters
Children
Remoter issue
• business partners (but not co-direct ors) • trustees of trusts set up by t he individual or any of his immediat e f amily • nominees (a nominee is simply an individual who owns shares on behalf of someone else).
Example 1
Julie invit es t he f ollowing people r ound t o dinner . Which of t hem ar e associat ed wit h her?
Yes No Her sister Her sist er ’s husband Her cousin Her uncle Her business par t ner Her gr andmot her Her invest ment adviser
254 Principles of Business Taxat ion ‘Finance Act 2006’
Example 2
Reynolds Limit ed is owned as f ollows:
Tim Reynolds Judith Reynolds Alison Reynolds (Tim’s wife) (Tim’s daught er )
40% 40% 20%
Reynolds Limit ed
I s Reynolds Limit ed a close company?
Example 3
East ender s Limit ed is owned as f ollows:
* Phil Mitchell 11% * Pauline Fowler 11% * Dor ot hy Cot t on 11% * Pat Evans 11% * Terry Raymond 6% Gary Hobbs 5% Ot her s – owing less t han 5% 45% 100% * = Direct or
I s East ender s Limit ed a close company?
Does your answer change if Gar y Hobbs is appoint ed a direct or?
Example 4
Tr ot t er s I ndependent Tr ader s Limit ed is owned as f ollows:
Derek Trotter 20% Rodney Tr ot t er (Der ek’s br ot her ) 7% Albert Trotter (Derek’s uncle) 5% Boycee 10% Mar lene (Boycee’s wif e) 3% Tr igger 6% Cassandr a (Rodney’s gir lf r iend) 4% Ot her s (1% each) 45% 100%
I s t he company close?
Close Company Def init ion 255
Example 5
Bill and Ben ar e br ot her s
Bill Ben
100% 100%
Flower Ltd Pot Ltd
Ar e t he companies close? Ar e t he companies associat ed f or t he pur pose of det er mining t he r at es of t ax payable?
C19.4 Exceptions s.414(1)
Cer t ain companies will not be close companies. These ar e: 1) non r esident companies; 2) r egist er ed f r iendly or indust r ial societ ies building societ ies and lif e assur ance companies; 3) companies cont r olled on or behalf of t he cr own; 4) companies cont r olled by open companies; 5) quot ed companies wit h subst ant ial public int er est .
C19.5 Quoted companies with substantial public interest s.415
The except ion applies t o a company t hat is quot ed on t he st ock exchange and has had dealing in it s shar es in t he last t welve mont hs.
I n addit ion t he public must hold at least 35% of t he vot es and t he pr incipal member s must hold less t han 85%.
The public is def ined as including: • Any non close company • Open pension f unds • Shar es held by per sons other t han pr incipal member s
Dir ect or s, t heir associat es and companies t hey cont r ol, can never be included as member s of t he public.
The pr incipal member s ar e t he f ive biggest shar eholder s who hold at least 5% of s.415(6) t he vot ing power in t he company. Wher e t her e is a t ie to be the f if th biggest shar eholder t hen we include 6 or what ever higher number of pr incipal member s is necessar y.
256 Principles of Business Taxat ion ‘Finance Act 2006’
Example 6
Cuent ame plc is a company list ed on t he st ock exchange wit h dealings in t he last t welve mont hs t he shar es ar e held as f ollows:
Mer cedes Alcant ar a 24 Ant onio Alcant ar a (Mer cedes’s husband) 10 I nes Alcant ar a (Mer cedes’s daught er ) 4 Eugenio (f amily pr iest ) 3 Don Pablo (Ant onio’s boss) 7 Nieves Fer nando 2 Bar r io Lt d (open company) 25 J ubilacion (open pension f und) 13 Ot her s all less t han 3% 12 100
Mer cedes, Don Pablo and Nieves ar e dir ect or s of t he company.
I s t he company close?
Close Company Def init ion 257
Answer 1
Yes No Her sist er Her sist er ’s husband Her cousin Her uncle Her business par t ner Her gr andmot her Her invest ment adviser
Answer 2
Reynolds Limit ed is a close company as over half of t he shares (in t his case all of t he shar es) ar e owned by 5 or f ewer par t icipat or s.
Answer 3
The 5 “lar gest ” shar eholder s ar e:
Phil 11% Pauline 11% Dot 11% Pat 11% Terry 6% 50%
This is not cont r ol by f ive or f ewer shar eholder s (not mor e t han 50%) so t he company is not close.
If Gar y is appoint ed as a dir ect or , t hen 55% of t he shar es ar e owned by t he dir ect or s. This is cont r ol by any number of dir ect or shar eholder s so t he company would become close.
Answer 4
The t op 5 shar eholder s in t he company ar e as f ollows:
Der ek (including Rodney) 27% Boycee (including Mar lene) 13% Tr igger 6% Albert 5% Cassandr a 4% 55%
This is cont r ol so t he company is close.
258 Principles of Business Taxat ion ‘Finance Act 2006’
Answer 5
Each of t he companies is a close company because t hey ar e each cont r olled by j ust one per son.
Bill and Ben ar e br ot her s and t hey each wholly own t heir own companies. Under s.416(6) ICTA 1988 we must appor t ion holdings bet ween associat es. Ther ef or e we should appor t ion Ben’s holding in Pot t o Bill. That means t hat Bill cont r ols bot h Flower and Pot .
We should also appor t ion Bill’s holding in Flower t o Ben, which also means t hat Ben cont r ols bot h Flower and Pot . That would mean, t her ef or e, in t he absence of any special r ules t hat t hose t wo companies would be associat ed wit h each ot her even t hough Bill and Ben’s companies may have not hing t o do wit h each ot her ; t hey would simply be associat ed because t hey ar e cont r olled by f ellow f amily member s.
However , ESC C9 which deals wit h associat es f or small companies r at e pur poses, will ignor e t he appor t ionment r ules pr ovided t her e is not subst ant ial commer cial int er dependence bet ween t he t wo companies.
Put t ing t his int o t he cont ext of an example, assume t hat Flower Limit ed makes f ur nit ur e and Pot Limit ed sells f ur nit ur e. I f Pot Limit ed only sold f ur nit ur e pr oduced by Flower Limit ed, and Flower Limit ed only supplies f ur nit ur e t o Pot Limit ed, t her e would be commer cial int er -dependence. Pot is t ot ally dependent upon Flower f or it s supplies, and Flower is t ot ally dependent on Pot f or it s mar ket .
I f , however , Flower only sold f ur nit ure t o Pot but Pot bought f ur nit ur e f r om loads of dif f er ent supplier s, and was not dependent upon Flower , t hen t her e may not be commer cial int er -dependence. I t is not a st r aight f or war d t est as t he companies do not need t o be dependant on each other in t he same way or t o t he same ext ent . Ult imat ely it will depend on all t he f act s. The Revenue will not j ust conf ine t hemselves t o consider at ion of t r ading t r ansact ions, t hey will also look at t he administ r at ion and dir ect or ship of t he companies t he pr emises used and ot her ar r angement s ent er ed int o such as int er company loans.
Close Company Def init ion 259
Answer 6
I s t he company cont r olled by t he dir ect or s
Mercedes 38 Don Pablo 7 Nieves 2 47% No
I s t he company cont r olled by f ive or f ewer shar eholder s
Bar r io Ltd 25 Mer cedes 38 63% Yes
I s t he company cont r olled by an open company?
No as Bar r io Lt d only holds 25%
I s t he company wit hin t he quot ed company except ion?
The public hold
Bar r io Ltd 25 J ubilacion 13 Eugenio 3 Others 12 53%
The pr incipal member s hold
Bar r io Ltd 25 J ubilación 13 Mer cedes 38 Don Pablo 7 83%
Conclusion: it is not a close company
Not e: I n calculat ing Mer cedes’ shar eholding we include t he shar es of her husband and daught er f or all t est s.
Nieves cannot be a member of t he public as she is a dir ect or even t hough she is not a pr incipal member .
Eugenio is not a pr incipal member as he holds less t han 5%, however , he is a member of t he public.
260 Principles of Business Taxat ion ‘Finance Act 2006’
SUMMARY – CLOSE COMPANY DEFINITION
A close company is a company t hat is r esident in t he UK and cont r olled by eit her 5 or f ewer par t icipat or s or any number of par t icipat or dir ect or s.
I n looking at a per son’s shar eholding we consider shar es held by t heir associat es.
For close company pur poses associat e includes: Spouse, par ent s and r emot er f or bear s, childr en and r emot er issue and siblings.
Ther e ar e except ions which include; - r egist er ed indust r ial societ ies, f r iendly societ ies, building societ ies and lif e assur ance companies - companies cont r olled on behalf of t he cr own - companies cont r olled by open companies - quot ed companies wit h subst ant ial public int er est .
The quot ed company except ion only applies if t he company is quot ed on t he st ock exchange wit h dealings in it s shar es in t he last t welve mont hs. I n addit ion t he pr incipal member s must hold less t hen 85% of t he vot es and t he public at least 35%.
Dir ect or s and t heir associat es can never be member s of t he public. Non-close companies and open pension f unds can be member s of t he public even if t hey ar e pr incipal member s.
C20a: CLOSE COMPANY IMPLICATIONS – PART 1
This chapt er looks at t he f ollowing ar eas: - t he impact of being a close company on t he company and it s shar eholder s; - t he impact of a company making a loan t o one of it s shar eholder s.
St at ut or y r ef er ences in t his chapt er ar e t o I CTA 1988 unless st at ed ot her wise.
C20a.1 Introduction
Close company r ules exist t o pr event shar eholder s and dir ect or s of close companies f r om using t hose companies as an ext ension t o t heir own pr ivat e banking f acilit ies wit hout paying any t ax! Rules exist wit h r egar d t o:
• loans to participators and • benefits provided to participators.
C20a.2 Loans to participators
Jack is both a director and shareholder of Vine Limited. Within the company’s books Jack is likely to have a current account, where amounts he is entitled to s. 419 f r om t he company ar e cr edit ed and amount s he t akes out ar e debit ed.
J ack is ent it led t o a salar y, af t er t ax, of £ 80,000. The company will debit salar y cost s and cr edit J ack’s cur r ent account . The salar y it self is t axed as ear nings using t he PAYE syst em.
J ack is also ent it led t o dividends f r om t he company of £ 50,000. The company will debit dividends and credit Jack’s cur r ent account . The dividends t hemselves will be t axed on J ack at t he usual dividend r at es and higher r at e t ax may be due.
We can see t hat J ack is ent it led t o wit hdraw a t ot al of £ 130,000 f rom t he company. Assume t hat J ack act ually t akes out £ 150,000. J ack has bor r owed an ext r a £ 20,000 f r om t he company by way of a “loan t o a par t icipat or ”.
It is t his loan t hat t he close company r ules seek t o t ax under t he pr ovisions of s.419 I CTA 1988.
C20a.3 S.419 tax
Close companies which ar e not liable t o pay t heir cor por at ion t ax by inst alment s will be r equir ed t o pay s.419 tax on their normal due date, i.e. 9 months and s. 419(3) 1 day f ollowing t he end of t he char geable account ing per iod.
The tax is calculated as 25% of the loan and is payable by t he company.
262 Principles of Business Taxat ion ‘Finance Act 2006’
The amount of the loan is t aken as t he lower of the amount outstanding on • the last day of the chargeable accounting period or • the normal due date. For lar ger close companies s. 419 t ax is added t o t he amount of t ax due by inst alment s which adds a hor r endous complicat ion t o t he inst alment s syst em!
Example 1
Jack bor r owed £ 20,000 f r om Vine Limit ed (a small close company) on 30 Sept ember 2005. He will r epay it as f ollows:
30.9.06 Repaid £ 10,000 30.9.07 Repaid £5,000 30.9.08 Repaid £5,000
Vine Limit ed has a 31 December account ing dat e.
How much t ax is due under s.419 and when is it due?
C20a.4 Repayment of s.419 tax
Wher e t he loan is eit her r epaid by t he par t icipat or or waived by t he company (in ot her wor ds wr it t en of f , wit h t he par t icipat or being r eleased f r om any f ur t her r epayment s), t ax pr eviously paid under sect ion 419 will be ref unded back t o t he company.
The refund is made by reducing the company’s tax liability for the chargeable accounting period in which the loan is repaid or waived. As most close companies ar e small, t his will nor mally be nine mont hs and one day f r om s. 419(4) t he end of t he account ing per iod in which t he r epayment or r elease of t he loan is made.
Example 2
In t he pr evious example, Vine Limit ed paid s.419 t ax of £ 2,500 on 1.10.05 in r espect of a loan out st anding of £ 10,000.
The loan is r epaid as f ollows: 30.9.07 £ 5,000 30.9.08 £ 5,000
How much s.419 t ax will be r ef unded t o Vine Limit ed and when?
Close Company I mplicat ions – Par t 1 263
C20a.5 Implications for the participator
I f a company waives a loan t o a par t icipat or t he company will r eceive a r epayment of t he s.419 t ax. The individual has r eceived r eal money f r om t he s. 421(1) company. The participator t her ef or e will be treated as receiving a dividend equal to the amount of the loan waived.
The dat e of r eceipt of t he dividend will be t he dat e of t he loan waiver . An individual will pay higher rate tax via self assessment if he is a higher rate t axpayer .
Illustration 1
Heppel Limit ed, a small close company, advanced £ 15,000 t o Fr ed, who is a dir ect or and shar eholder , on 31 December 2005. On 31 December 2006 Fred r epaid £ 5,000 and Heppel Limit ed waived a f ur t her £ 9,000. Heppel Limit ed has a 31 Mar ch year end.
I mplicat ions f or Heppel Limit ed:
The loan is advanced on 31 December 2005, which is in t he company’s account ing period ended 31 March 2006. S.419 t ax is due nine mont hs and one day lat er , on 1 J anuary 2007:
25% x £ 15,000 = £ 3,750
This t ax is r ef unded when t he loan is eit her waived or r epaid. A t ot al of £ 14,000 is r eleased f r om t he loan on 31 December 2007, which is dur ing t he company’s year ended 31 Mar ch 2008. Any r ef und is made nine mont hs and one day lat er , on 1 J anuar y 2009:
25% x £ 14,000 = £ 3,500
I mplicat ions f or Fr ed:
Fr ed is deemed t o r eceive a dividend of £ 9,000 on 31 December 2007, which is in t ax year 2007/ 08. Assuming t hat Fr ed is a higher r at e t axpayer , he will be t axed on t hat dividend. The dividend it self is gr ossed up f or t he t ax cr edit of 10%. £ 100 10,000 £ 9,000 x 90
Tax at 32.5% 3,250 Tax credit: £10,000 x 10% (1,000) Higher r at e t ax due on 31 J anuar y 2009 2,250
A simpler way of calculat ing t his higher r at e t ax would be t o t ake t he net dividend of £ 9,000 and multiply it by 25% which leads us to the same f igure of £ 2,250.
264 Principles of Business Taxat ion ‘Finance Act 2006’
Answer 1
Loan advanced 30.9.05 which is dur ing t he company’s year end 31.12.05
Amount out st anding: At end of CAP i.e. at 31.12.05 = £ 20,000 At due dat e of payment f or CT i.e. at 1.10.06 = £ 10,000
So t he s.419 t ax due on 1.10.06 is:
£10,000 x 25% = £2,500
Answer 2
Fir st r epayment on 30.9.07 is dur ing t he company’s year ended 31.12.07
Ref und made on 1.10.08 is:
£5,000 x 25% = £1,250
Second r epayment on 30.9.08 is dur ing t he company’s year ended 31.12.08
Ref und made on 1.10.09 is:
£5,000 x 25% = £1,250
Close Company I mplicat ions – Par t 1 265
SUMMARY – CLOSE COMPANY IMPLICATIONS (1)
Wher e a close company makes a loan t o a shareholder it is f ir st necessar y t o see if it is exempt . I f not , t her e will be a s.419 char ge on t he company equal t o 25% of t he amount of t he loan.
This will be payable wit h t he CT liability f or t he per iod, unless t he loan has been r epaid bef or e t he t ax is due.
Wher e t he t ax is payable, it can be r eclaimed by t he company if t he loan is r epaid.
I f t he loan is wr it t en of f , t he company can reclaim t he t ax but t he recipient will become liable t o income t ax as t hough t he loan wr it t en of f was a dividend.
C20b: CLOSE COMPANY IMPLICATIONS – PART 2
This chapt er looks at : - t he impact of close companies pr oviding benef it s t o shar eholder s who ar e not employees; - t he consequences of being a close invest ment holding company.
St at ut or y r ef er ences in t his chapt er ar e t o I CTA 1988 unless st at ed ot her wise.
C20b.1 Loans excluded from s.419 Charge s. 420
Loans made in the ordinary course of business of the company ar e excluded f r om t he s.419 char ge. Under t his exclusion t he close company must be a bank or similar moneylender .
I n Br ennan v Deanby I nvest ment Company Limit ed t he company made a ser ies of loans t o it s Chair man and one ot her loan t o an independent per son. I t was held in t his case t hat , alt hough t he Chair man was paying commer cial int er est t o t he company on t he loans, s.419 st ill applied because t he making of a number of dif f er ent loans t o t he same connect ed per son did not const it ut e t he business of a moneylender and t he company t her ef or e lost it s appeal.
Ther e is also an exclusion f or t he supply of goods or ser vices in t he or dinar y s.420(1) cour se of t he t r ade unless t he cr edit per iod is longer t han nor mal.
Ther e is also an exclusion f or loans of no mor e t han £ 15,000 made t o a f ull-t ime s.420(2) direct or or employee who is ent it led t o no more t han 5% of t he company’s asset s on a winding-up. When calculat ing t his 5%, we must also t ake account of holdings owned by his associat es.
But if t he bor r ower acquir es a 5% holding at a t ime when t he whole or par t of s.420(2) t he loan r emains out st anding, t hen he will be t r eat ed as r eceiving a loan at t hat t ime.
Illustration 1
Green Lt d a close company wit h a December year end makes a loan of £ 12,000 t o J im who is a f ull t ime wor king dir ect or and holds 3% of t he shar e capit al on 1 Oct ober 2006. On t he 1 January 2007 Jim r epays £ 5000 of t he loan. On t he 31 Mar ch 2007 J im incr eases his shar eholding t o 6%.
At t he t ime of t he loan it is cover ed by t he except ion as it is f or less t han £ 15,000, and t o a f ull-t ime wor king dir ect or who does not hold a mat er ial int er est in t he company. No s.419 t ax is payable.
The r epayment of £ 5,000 has no implicat ions f or s.419.
Close Company I mplicat ions – Par t 2 267
On 31 March 2007 Jim acquired f urt her shar es and now holds mor e t han 5%. Thus Green Lt d is t r eat ed as having made a loan on 31 Mar ch 2007 equal t o t he loan out st anding which is £ 12,000 - £ 5,000 = £ 7,000.
S.419 t ax is payable in r espect of t he account ing per iod ended 31 December 2007. I f t he company is not lar ge it will be due on 1 Oct ober 2008.
C20b.2 Beneficial loan interest s. 418
Wher e a company makes a loan to a participator, and eit her charges no interest, or char ges int er est below the official rate, a benefit in kind is levied on the participator. Wher e t he par t icipat or is an employee or dir ect or t his will need t o be r epor t ed on his P11D and will be t axed under t he ear nings r ules.
Illustration 2
Campbell Limit ed, a close company, lends £ 10,000 t o Ted who is a shar eholder and employee in t he company. The loan is advanced on 1 Oct ober 2005 and Ted r epays it t o Campbell Limit ed on 30 Sept ember 2006. Assuming t hat t he benef icial int er est r at e is 7.25%, Ted’s benef it in kind will be as f ollows.
For t he t ax year 2004/ 05, we look at t he period 1 Oct ober 2005 t o t he 5 April 2006 which is 187 days and t heref ore t he benef it will be:
187 £ 10,000 x 7.25% x = £ 371 365
For t he next t ax year 2006/ 2007, we look at t he period 6 April 2006 t o t he 30 Sept ember 2006, t hat is a per iod of 178 days, and t her ef or e t he benef it will be:
178 £ 10,000 x 7.25% x = £ 354 365 These f igur es will need t o be r epor t ed on Ted’s P11Ds f or t hose separ at e t ax year s.
C20b.3 Benefits to participators s. 418
Wher e a shar eholder is an employee or dir ect or of a close company, any benef it s he r eceives ar e t axed under t he ear nings r ules. Ther ef or e, in t he absence of any special r ules, wher e shar eholder s are not dir ect or s or employees, t hey would not pay any t ax on benef it s t hey r eceive. This is t he r eason f or S.418 which will treat those benefits as net dividends paid to those shareholders. The net dividend is calculat ed using t he nor mal benef it r ules f or ear nings.
S.418 applies t o any expense incur r ed by t he company in connect ion wit h t he pr ovision of living or ot her accommodat ion, ent er t ainment , domest ic or ot her ser vices or ot her benef it s or f acilit ies of what ever nat ur e.
268 Principles of Business Taxat ion ‘Finance Act 2006’
S.418 does not include: 1) Benef it s t o employees which ar e t axed under t he ear nings r ules; 2) Living accommodat ion if it is wit hin t he except ions wit hin t he ear nings r ules; 3) Pensions, annuit ies or lump sums paid t o t he childr en, spouse or dependant s of an employee on t he employee’s deat h or r et ir ement .
Illustration 3
J oan r eceives a company car f r om Mor ley Limit ed, a close company. The car has
a list pr ice of £ 21,000, and CO2 emissions of 188g/ km. She is a shar eholder in t he company but not an employee or a dir ect or. I n t ax year 2006/ 07, she will be t r eat ed as r eceiving a net dividend calculat ed using t he benef it in kind r ules.
£ Car Benef it [185 – 140]/ 5 = 9 + 15 = 24% £ 21,000 x 24% = £ 5,040
Deemed gr oss dividend 5,600 100 £ 5,040 x 90
Tax at 32.5% 1,820 Tax credit: £5,600 x 10% (560) Higher r at e t ax due 1,260
That gives us a net dividend of £ 5,040 which we gr oss up at 100/ 90 t o £ 5,600.
The t ax will be added t o J oan’s t ax liabilit y f or 2006/ 07 and t he t ax must be paid by 31 J anuary 2008.
C20b.4 Close investment holding companies
All close companies ar e Close I nvest ment Holding Companies (CI HCs) unless t hey s.13A exist wholly or mainly f or one of t he per mit t ed pur poses which basically ar e t o be a t r ading company or a member of a t r ading gr oup or t o make invest ment s in land.
Wher e t he company is a CI HC, it cannot use the small and marginal company rates of tax. I nst ead such companies will always be taxed at the full rate of cor por at ion t ax (cur r ent ly 30%), r egar dless of t he level of it s pr of it s.
C20b.5 Jointly held property
Fr om 6 Apr il 2004 wher e shar es in a close company ar e held j oint ly by a husband and wif e any income from the shares will be taxed according to actual ownership. Previously t he income was t axed 50:50 unless an elect ion was made f or t axat ion accor ding t o act ual owner ship.
Close Company I mplicat ions – Par t 2 269
C20b.6 Summary
Wher e a benefit is paid to an employee or director, as f ar as t he r ecipient is concer ned, t he benef it is t axed in t he usual way under t he ear nings r ules and r epor t ed on form P11D. As f ar as t he company is concer ned, t he cost of pr oviding t hat benef it is t ax deduct ible in t he usual way.
As f ar as a non-wor king par t icipat or r ecipient is concer ned, t he individual will be treated as receiving a dividend on any s.418 benefits received. The value of t he dividend will be calculat ed using t he nor mal benef it r ules and will be subj ect t o higher r at e t ax wher e appr opr iat e.
As f ar as t he company is concer ned, t he cost of pr oviding t hat benef it will not be deductible as it is t r eat ed as an appr opr iat ion f r om pr of it .
The except ion t o t his r ule is the write off of a loan to a participator. A loan write of f is always treated as a distribution.
270 Principles of Business Taxat ion ‘Finance Act 2006’
SUMMARY – CLOSE COMPANY IMPLICATIONS (2)
I f a close company pr ovides a benef it t o an employee/ shareholder , it is t axed under t he nor mal ear nings r ules. I f t he shar eholder is not an employee, t he value of t he benef it is t r eat ed as a dividend paid t o t he shar eholder .
The wr it e of f of a loan t o a par t icipat or is always t r eat ed as a dividend.
Close I nvest ment Holding Companies, ar e companies whose main act ivit y is making invest ment s, r at her t han t r ading. A CI HC is always t axed at t he f ull CT r at e, cur r ent ly 30%.
The income f r om j oint ly held shar es will be t axed accor ding t o act ual owner ship of each spouse f r om 6 Apr il 2004.
C21: INVESTMENT COMPANIES
This chapt er explains t he basic r ules in r elat ion t o t he t axat ion of companies wit h invest ment business including: - def init ion of an invest ment company and a company wit h invest ment business; - t r eat ment of management expenses pr e and post 1 Apr il 2004; - change in owner ship pr ovisions f or companies wit h invest ment business; - def init ion of CI HC; - r elief available f or invest ment companies f or losses on sale of shar es.
C21.1 Definition
A company with investment business is def ined in t he legislat ion as a “company s.130 whose business consist s wholly or partly in t he making of invest ment s”.
This def init ion was int r oduced by FA 2004 wit h ef f ect f rom 1 April 2004 and is par t icular ly r elevant in r elat ion t o claiming r elief f or management expenses.
A company wit h invest ment business is not simply a company t hat holds invest ment s or r eceives invest ment income. I t is a company t hat has a business of making invest ment s.
Prior t o FA 2004, a company had t o be an investment company in or der t o obt ain r elief f or management expenses. An invest ment company is a “company whose business consist s wholly or mainly in t he making of invest ment s and the principal part of whose income is derived therefrom”.
I t can be seen t hat t he def init ion of a company wit h invest ment business is wider t han t hat of an invest ment company and t hat all invest ment companies ar e also companies wit h invest ment business.
The t er m invest ment company is now only r elevant when consider ing which s.573 companies may claim r elief against income f or capit al losses on sales of cer t ain shar es. Mor e on t his lat er .
The Revenue, in Tax Bullet in 19, t ell us t o look at t he t ot alit y of t he company' s f unct ions and act ivit ies t o ident if y a business wholly or partly in the making of invest ment s.
Consider a f lat management company t hat owns t he f r eehold of a block of f lat s and all t he f lat owner s have a shar e in t he company. This t ype of company would not be t r eat ed as a company wit h invest ment business as it s business is not t hat of making invest ment s; it s business is t he pr ovision of management ser vices.
272 Principles of Business Taxat ion ‘Finance Act 2006’
I n t he case of Cook v t he Medway Housing Societ y Limit ed in 1997, it was held t hat a Housing Associat ion pur chasing pr oper t y f r om a Local Aut hor it y, and r eceiving r ent al income, wit h t he aim of applying any pr of it s t o eit her buy mor e pr oper t y or pass it t o char it y, was an investment company because it had a business of making invest ment s and had an int ent ion of making a pr of it able r et ur n. I t did not mat t er t hat t he r et ur n was never going t o be paid t o t he shar eholder s. The int ent ion was enough f or invest ment company st at us t o apply.
We can cont r ast t his wit h t he case of Tint er n Close Resident s Societ y Lt d. I n 1995 t his company owned and managed an est at e t hat consist ed of 21 houses 1 f lat and 22 lock up gar ages. The company’s income consist ed of member s’ subscr ipt ions and gr ound r ent s. I t was held t hat t he main f unct ion and act ivit y of t he company was t he management and maint enance of t he pr oper t y. Alt hough it had been f or med t o pur chase land, it was not f or t he pur pose of t ur ning t he land t o pr of it .
I n t he case of J ar r et t v O' Neill and Br ennan Const r uct ion Limit ed, it was held t hat a company deposit ing f unds int o a bank account and r eceiving int er est , did not const it ut e a business and t her ef or e, f or associat ed company pur poses, it was t r eat ed as dor mant .
C21.2 Management expenses post 1 April 2004
From 1 April 2004, t he abilit y t o claim management expenses has been ext ended t o include companies with an investment business - not j ust t hose qualif ying as invest ment companies - and also t o include non UK resident companies.
The ext ension t o companies wit h an invest ment business will be impor t ant f or companies who hold shar es in subsidiar ies as well as having t heir own t r ade.
FA 2004 r eplaced t he exist ing r ules r elat ing t o management expenses wit h a new s.75 t hat applies t o all account ing per iods beginning on or af t er 1 Apr il 2004. Wher e an account ing per iod st r addles t his dat e t he company will be t r eat ed as having t wo not ional account ing per iods.
Management expenses ar e deduct ible against t he t ot al pr of it s of a company wit h s.75A an invest ment business. The expenses will be deducted based on when they are debited in the accounts. The account s must be dr awn up in accor dance wit h GAAP. Wher e t he per iod of account exceeds t welve mont hs, management expenses will be t ime appor t ioned.
No expenses can be deduct ed as management expenses if they are otherwise s.75(2) deductible for tax.
Expenses of a capital nature are not management expenses, unless t hey r elat e s.75(3) t o capit al allowances. Thus f or t he f ir st t ime t her e is st at ut or y aut hor it y t o exclude capit al expendit ur e f r om management expenses. This has ar isen as a r esult of case law in t his area, as we shall see below.
I nvest ment Companies 273
Expenses will only qualif y f or a deduct ion t o t he ext ent t hat t hey ar e made in s.75(4) r espect of t he company’s invest ment business and t o t he ext ent t hat t hey ar e not made for an unallowable purpose.
An invest ment is held f or an unallowable purpose to the extent that it is not held f or a business or ot her commer cial pur pose, or is held f or act ivit ies out side t he char ge t o cor por at ion t ax. This will exclude invest ment s held f or social or r ecr eat ional pur poses and invest ment s of a non r esident company wit h a per manent est ablishment in t he UK, if t he invest ment is not par t of t he business of t he PE.
Surplus capital allowances are added to management expenses.
Examples of management expenses include:
(i) Commissions paid to agents, such as st ockbr oker s who manage t he por t f olio of shar es;
(ii) Capital allowances on plant used to manage the investments, such as comput er equipment used t o monit or t he pr ogr ess of t he invest ment s;
(iii) Reasonable salaries, which includes r edundancy cost s. The Revenue may seek t o disallow excessive dir ect or s’ r emuner at ion wher e it cannot be j ust if ied given t he amount of input t he dir ect or s have in managing t he invest ment s against t he r et ur n der ived f r om t hem. I f t he Revenue f eel t he amount is excessive, t hey will seek t o disallow some management expenses. However , t hey will st ill t ax t he dir ect or ’s f ull salar y and subj ect t he company t o Class 1 secondar y Nat ional I nsur ance on t he salar y being paid;
(iv) Premises costs, f or inst ance r elat ing t o t he of f ices used t o manage t he invest ment s;
(v) Audit and accountancy costs.
Remember t hat commitment fees and guarantee commissions, ar e par t of t he cost of raising loans, and so are not management expenses - they will be deductible f rom DI I I under the loan relationships r ules.
Any expenses r elat ing t o specif ic income must be set against t hat sour ce only, f or example under Schedule A. Expenses r elat ing specif ically t o pr oper t ies being let out must be set against t he Schedule A income, not t r eat ed as a management expense.
All I nt angible Fixed Asset s held will be held f or non-trading purposes. Thus f r om 1 Apr il 2002 r oyalt y payment s and r eceipt s will go int o t he DVI pool.
274 Principles of Business Taxat ion ‘Finance Act 2006’
C21.3 Management expenses prior to 1 April 2004
Many of t he r ules we looked at above applied pr ior t o t he FA 2004 changes hence we will j ust concent r at e on t he dif f er ences her e.
I n account ing per iods beginning before 1 April 2004, management expenses could only be deduct ed by UK resident invest ment companies.
They wer e deduct ible in t he account ing per iod in which t hey wer e disbursed.
Ther e ar e transitional provisions t o ensur e t hat amount s ar e not deducted twice or missed, as we move t o deduct ion according t o when t he expense is debit ed in t he account s.
The old s.75 did not include any r ef er ence t o capit al expendit ur e or t o invest ment s held f or unallowable pur poses.
C21.4 Management expenses case law
I n Capit al and Nat ional Tr ust Lt d v Golder t he point at issue was whet her t he company could claim r elief f or br okerage and st amp dut ies as management expenses. I t was held t hat t hese sums wer e not allowable as management expenses. The r eason was t hat , wher e invest ment s ar e being changed, ' management ' does not ext end beyond t he time when a purchase or sale is ef f ect ed. Ther ef or e, expendit ur e af t er t hat t ime cannot be an expense of management ; it is ' an int egr al par t of t he selling pr ice' .
Sun Lif e Assur ance Societ y v Davidson also looked at t he issue of whet her t he company could claim r elief f or br okerage and st amp dut ies as management expenses. The company was a life assurance company. I t included in it s management expenses claim sums f or broker age and st amp dut ies in connect ion wit h pur chases and sales of invest ment s. Sun Lif e sought t o dist inguish it s business f r om t hat of Capit al and Nat ional Tr ust Lt d because, it said, buying and selling st ocks and shar es was par t of it s t rading act ivit y. I t was decided t hat t hese sums wer e not allowable as management expenses. They concluded t hat t he br oker age and st amp dut ies wer e not gener al expenses of conduct ing t he Societ y' s business, but expenses of t he pur chase of invest ment .
Alt hough t he j udgement s in t hese t wo cases per haps say mor e about what is not an expense of management , t her e ar e t hr ee br oad point s t hat ar e wor t h not ing. • The wor ds have no special meaning. • The phr ase does not include ever y expense. • The phr ase should be given a ' wide' meaning.
I n anot her case it was st at ed t hat t he pur pose of management expenses is not t o give invest ment companies an advant age over t r ading companies, but simply t o pr event t hem being at a disadvant age.
I nvest ment Companies 275
So we need t o dr aw a dist inct ion bet ween t he cost s of a change in a company' s invest ment s, (including it s shar e por t f olio) and t he acquisition of t he shar e capit al of a new subsidiar y company, as par t of t he expansion of t he gr oup. The cost s of a change in t he company' s invest ment s may be allowable on t he aut horit y in t he Sun Lif e case. The costs of acquisition of the share capital of a new subsidiary company are not management expenses.
Thus when we ar e looking at t he pur chase of a company by a company wit h invest ment business, we have t o consider each st age in t he pr ocedur e. To begin wit h, t he company may be looking at sever al companies and so at t his st age t he cost s incur r ed will be in r elat ion t o making and managing it s invest ment s. However at some point when a specif ic t ar get is ident if ied, t he cost s such as due diligence will become par t of t he capit al cost of pur chase.
The Revenue have r ecent ly lost a case of Camis v At kinson at t he Cour t of Appeal. I n t his case a company incur r ed subst ant ial expendit ur e in evaluat ing a pr oj ect ed acquisit ion of anot her company. The company did not pr oceed wit h t he acquisit ion, and claimed r elief f or t he expendit ur e as management expenses. The Cour t of Appeal held t hat t he r elevant act ivit ies ‘wer e all par t of t he pr ocess of manager ial decision-making’ and t hat capit al expendit ur e was not excluded by t he legislat ion as in f or ce at t he r elevant t ime. This decision was t aken bef or e FA 2004 was passed. As we have seen above, t he new s.75(4) st at es t hat expenses of a capit al nat ur e ar e excluded f r om deduct ion as management expenses.
I n t he case of J ames Snook and Co v Blasdale, a t r ading company was bought . As par t of t he t akeover , t he exist ing dir ect or s agr eed t o r esign. They wer e paid compensat ion f or loss of of f ice. I t was held t hat t he cost was not deduct ible as it was t oo closely linked wit h t he t akeover of t he company and t hus f or med par t of t he capit al cost of t he t akeover .
C21.5 Relief for management expenses
Management expenses ar e automatically set against investment income and gains in the current accounting period. This r elief is aut omat ic and compulsor y.
Management expenses ar e deduct ed before charges on income and bef or e any loss relief claims under sect ion 393A.
Wher e t he management expenses exceed the gross income and gains in the
current period, t hey ar e “excess”. I f the company is part of a group they may
be transferred to a fellow 75% owned company, upon making a claim. s. 75(8) Failing t hat , excess management expenses ar e carried forward and set against f ut ur e income and gains of t he company.
276 Principles of Business Taxat ion ‘Finance Act 2006’
C21.6 Change in ownership provisions s.768B
We must also be awar e of t he change in owner ship pr ovisions f or a company wit h invest ment business. Ant i-avoidance pr ovisions apply t o prevent the carry forward of excess management expenses in pr escr ibed cir cumst ances.
I f in t he t hr ee year s leading up t o t he change in owner ship, or in t he t hr ee year s f ollowing t he change in owner ship, t her e has been a major change in the type of investments held, t hen excess management expenses will be st opped at t he dat e of change in owner ship.
For example if bef or e t he change in owner ship t he company held quot ed secur it ies and, f ollowing t he change, it held commer cial pr oper t y, t he Revenue would view t his as a maj or change in t he t ype of invest ment held. However , let us say t hat bef or e t he change of owner ship, t he company held quot ed secur it ies but af t er war ds, it held a dif f er ent por t f olio of quot ed secur it ies, so it sold t he previous holdings and replaced them with different ones. This is unlikely to be t r eat ed as a maj or change because t he company essent ially is st ill holding t he same t ype of invest ment s, t hat being quot ed secur it ies.
The ant i-avoidance pr ovisions also apply when a company’s act ivit ies ar e small and negligible prior to the change in ownership, and t hey ar e followed by a considerable revival. Excess management expenses will st op at t he dat e of t he change. This will be based on t he f act s and degr ee in each individual case but we need t o look at t he number of t r ansact ions t aking place each year , bef or e and af t er t he change in owner ship.
I n addit ion, a significant increase in the capital of the company in the three years immediately following the change of ownership, will give r ise t o a loss of excess management expenses. A signif icant incr ease is t he lower of t he company’s capit al doubling in t he f ir st t hr ee year s, or t he capit al incr easing by £ 1 million in t he f ir st t hr ee year s.
Illustration 1
The shar e capit al of a company wit h invest ment business bef or e t he change of owner ship is £ 200,000 and, in t he f ir st t hr ee year s f ollowing t he change, it incr eases t o £ 500,000. The capit al has mor e t han doubled and t her ef or e it has given r ise t o a signif icant change.
Taking anot her company wit h invest ment business, let us say it s shar e capit al bef or e t he change is £ 2 million and in t he t hr ee year s f ollowing t he change, it incr eases t o £ 3 million. Alt hough t he capit al has not doubled, it has incr eased by £ 1 million and t his will be seen as a signif icant incr ease and excess management expenses will be lost .
I nvest ment Companies 277
C21.7 Loan interest
I nt er est paid by companies wit h invest ment business on loans t aken out t o pur chase invest ment s is a Schedule D Case III debit. The t ax t r eat ment and r elief f or DI I I debit s was cover ed in t he ear lier chapt er on loan r elat ionships. Remember such int er est is never t r eat ed as a Schedule A expense or a management expense.
Commitment fees and guarantee commissions, ar e par t of t he cost of r aising loans, and not management expenses. They will be cover ed by loan r elat ionship r ules.
C21.8 Close investment holding companies (CIHCs) s.13A
A CI HC is any close company (i.e. one under t he control of 5 or f ewer shar eholder s) t hat does not exist wholly or mainly f or one of t he f ollowing pur poses;
(i) car r ying on a trade or t r ades on a commer cial basis; (ii) making invest ment s in land and letting the land to unconnected per sons; (iii) holding shar es and secur it ies or making loans t o gr oup companies; (iv) co-or dinat ing t he administ r at ion of gr oup companies; (v) being a member of a t r ading gr oup; (vi) being t he invest ment company in a gr oup.
All of t he pr of it s of a CI HC ar e charged at the full rate of cor por at ion t ax (30%).
C21.9 Losses on sale of shares
Wher e an invest ment company makes a capit al loss on t he disposal of shar es in cer t ain qualif ying companies, it may claim t o set that loss against income.
On making a claim wit hin t wo year s of t he end of t he account ing per iod of t he s. 573 loss, t he loss can be set against income f or t he accounting period of the loss, and if necessar y any previous accounting period ending in the 12 months before t he st ar t of t he account ing per iod of t he loss. This loss r elief is claimed bef or e any ot her deduct ions including management expenses and char ges. However claims under t he CVS r ules t ake pr ior it y.
To be able t o make t he s. 573 claim, t he company must be an investment company and have been so t hroughout a cont inuous period of six years. I f t his is not t he case it must not pr eviously have been a t r ading company. The company must have subscribed for shares in a qualifying trading company (as def ined by t he EI S r ules), which has not been associated with it from the date of subscr ipt ion t o t he dat e of disposal. Associat ed her e is t he wide meaning of control. Note t hat t his relief can only be claimed by investment companies. I t does not extend to companies with an investment business.
278 Principles of Business Taxat ion ‘Finance Act 2006’
SUMMARY – COMPANIES WITH INVESTMENT BUSINESS
A company wit h invest ment business is a company der iving it s income wholly or par tly f r om t he making of invest ment s.
The PCTCT of a company wit h invest ment business is f ound by adding t oget her invest ment income and gains and deduct ing management expenses.
Management expenses include agent ’s commissions, pr of essional f ees, pr emises cost s and r easonable dir ect or ’s salar ies, but exclude expenses of a capit al nat ur e or f or an unallowable pur pose.
Since 1 Apr il 2004 management expenses are deduct ible based on when t hey ar e debit ed in t he account s. Previously t hey wer e deduct ible when disbur sed.
I f management expenses exceed pr of it s, a company has “excess management expenses”. These excess management expenses can eit her be gr oup r elieved or car r ied f or war d.
The change in owner ship pr ovisions apply t o companies wit h invest ment business blocking t he carry f orward of management expenses.
An invest ment company is a company wher e business consist s wholly or mainly in t he making of invest ment s and t he pr incipal par t of whose income is der ived t her ef r om.
When an invest ment company has a capit al loss on t he disposal of shar es t hat it subscr ibed f or in a qualif ying company, it can claim t o set t hat loss of f against income of t hat per iod or t he pr evious per iod.
C22: CORPORATE VENTURING SCHEME
This chapt er out lines t he r elief s available f or invest ment s under t he CVS scheme cover ing in par t icular : - t he cor por at ion t ax r elief ; - what happens on sale of t he shar es; - condit ions f or t he r elief ; - capit al gains r elief including r elief f or losses; - ant i-avoidance; - claiming t he r elief .
C22.1 The Corporate Venturing Scheme (CVS) Sch 15 FA 2000
The scheme gives t ax r elief t o companies who invest in small unquot ed t r ading companies. The int ent ion is t o encour age lar ger companies t o invest in smaller companies – t he t ax r elief is an incent ive f or t hem t o do so.
Tax relief is given as a tax reducer – i.e. t he r elief r educes t he amount of cor por at ion t ax payable by t he invest ing company. The t ax r educer is usually 20% of the amount invested (or a lower amount if t he t ax r elief r educes t he CT liabilit y t o zero). There is no upper limit.
Illustration 1
On 1 May 2006, Gener ous Lt d subscr ibes f or £ 200,000 of new shar es issued by St ar t -Up Lt d, a company which sat isf ies t he condit ions of t he Cor por at e Vent ur ing Scheme. Gener ous Lt d has t axable pr of it s of £ 1.8m in t he year ended 31 Mar ch 2007. The cor por at ion t ax payable will be:
£ £1.8m x 30% 540,000 Less CVS r elief £200,000 x 20% (40,000) Gross cor por at ion t ax £ 500,000
Not e t hat t he CVS r elief could r educe a company’s t ax liabilit y t o zer o but it cannot cr eat e a t ax r epayment .
I f t he company sells the new CVS shares within 3 years, relief is withdrawn.
The relief wit hdrawn will eit her be:
(i) The original relief given if t he shar es ar e sold at a profit; or (ii) 20% x proceeds if t he shar es ar e sold at a loss.
280 Principles of Business Taxat ion ‘Finance Act 2006’
Illustration 2
Assume in t he above example t hat Gener ous Ltd sold its shares in Start-Up Ltd f or £ 125,000 on 1 December 2007.
As t he CVS shar es have been sold wit hin 3 year s of issue, cor por at ion t ax r elief is withdrawn. To withdraw the relief, t he Revenue will issue an assessment (under Schedule DVI ) in t he period in which t he relief was originally given (i.e., t he year of t he or iginal subscr ipt ion of t he shar es).
The r evised CT comput at ion f or t he year ended 31 March 2007 will be:
£ £1.8 m x 30% 540,000 Less CVS r elief or iginally given £200,000 x 20% (40,000) CT originally due 500,000 Add: CVS relief withdrawn £125,000 x 20% 25,000 Revised gr oss cor por at ion t ax £ 525,000
Not e t hat as t he shar es wer e sold at a loss, t he wit hdr awal of r elief is r est r ict ed t o 20% of pr oceeds.
C22.2 Conditions for CVS relief
Cer t ain condit ions must be sat isf ied t hr oughout t he qualification period of the Par a 3 Sch 15 FA2000 shares bot h by t he investing company (i.e. t he company acquir ing t he CVS shar es) and t he issuing company (i.e. t he company issuing t he new shar es t o t he invest or s).
The qualif icat ion per iod is a per iod st ar t ing wit h t he issue of t he shar es and ending:
• I mmediat ely bef or e t he third anniversary of the issue date wher e t he qualif ying t r ade is alr eady being car r ied on or ,
• I mmediat ely bef or e t he t hir d anniversary of t he dat e on which t he trade commences.
The invest ing company must not either: Par a 5&8 Sch 15 - have more than 30% of t he or dinar y shar es or vot ing r ight s of t he issuing FA2000 company, or - be able t o control t he issuing company (i.e. wit h it s associat es).
The invest ing company must car r y out a non-financial trade (e.g. it must not be Par a 10 an invest ment company et c). The invest ing company can be t he par ent company Sch 15 FA2000 of a gr oup, as long as t he gr oup car r ies out non-f inancial t r ades.
The invest ing company must subscr ibe f or new shar es in t he CVS company.
Corporat e Vent uring Scheme 281
The issuing company must sat isf y a number of condit ions, many of which ar e Par a 15 Sch 15 similar to the conditions a company must sat isf y in or der t o qualif y under t he FA2000 Enterprise Investment Scheme (EI S).
These ar e:
(i) t he company must not be list ed on a r ecognised St ock Exchange Par a 16 Sch 15 (i.e. it must be an unquoted company); and FA2000
(ii) t he company must carry out a qualifying trade wholly or mainly in Par a 23 the UK. Qualif ying t r ades will not include f inancial t r ades (e.g. Sch 15 account ing, shar e dealing et c), legal t r ades, pr oper t y dealing, FA2000 f ar ming or hot els; and
(iii) t he company’s asset s bef or e t he shar e issue must not exceed £7m Par a 22 Sch 15 and af t er t he shar e issue must not exceed £8m (t he limit s wer e FA2000 £ 15m and £ 16m pr ior t o 6th April 2006); and
Par a 36 (iv) t he cash raised must be used f or business pur poses within 2 Sch 15 years. At least 80% of t he cash must be used within 12 months; FA2000 and
(v) t he issuing company must not be a 51% subsidiar y of any company Par a 17 Sch 15 and at least 20% of it s shar es must be owned by independent FA2000 individuals.
(vi) t he company can be a par ent company as long as all it s subsidiar ies car r y on a qualif ying t r ade.
The shar es must be or dinar y shar es car r ying no pr ef er ent ial r ight s t o dividends or asset s on a winding up and must be subscribed f or in cash and f ully paid up at t he t ime of issue.
C22.3 Capital gains relief for CVS shares
I f t he CVS shar es ar e sold at a gain, it is possible t hat t he gain may be exempt under the substantial shareholdings rules. This exempt ion applies br oadly wher e t he holding is at least 10% and t he shar es have been held for at least a year. The subst ant ial shar eholdings r ules ar e explained in mor e det ail lat er in t his cour se.
Provided t hat t he shar es have been held for 3 years, t here will be no clawback of the tax relief initially given even if t he gain is exempt under t he subst ant ial shar eholdings r ules.
282 Principles of Business Taxat ion ‘Finance Act 2006’
I f t he CVS shar e gain is not exempt under t he subst ant ial shar eholdings r ules, Par a 73 Sch 15 then if the proceeds are used to acquire new CVS shares, the capital gain FA2000 may be deferred.
The amount of t he gain which may be def erred is t he lower of : (i) t he gain on t he CVS shar es; and (ii) t he amount r einvest ed.
The company may specif y a lower amount in t he claim if it wishes (f or example t o use up any capit al losses it may have).
The deferred gain will become chargeable when the company sells the new Par a 79 Sch 15 shares (unless pr oceeds ar e r einvest ed in new CVS shar es). FA2000
Illustration 3
J ones plc subscr ibes f or £ 100,000 of shares in I -Vent ur e Ltd (a CVS company) in February 2006 (RPI 194.2).
J ones plc sells t he shar es in J anuar y 2007 (RPI 198.6) f or £ 130,000.
As t he shares have been held f or less t han a year t he subst ant ial shar eholdings exempt ion will not apply her e. The capit al gain is:
£ Proceeds 130,000 Less cost (100,000) Less indexat ion 198.6 - 194.2 x £ 100,000 194.2 (2,266) I ndexed gain £ 27,734
I n Febr uar y 2007 (RPI 199.00), J ones plc subscr ibes £ 35,000 f or a 5% shar eholding in Risky Business Lt d, anot her CVS company. J ones Lt d can t her ef or e make a claim t o def er t he gain made in J anuar y 2007.
The maximum claim is t he lower of
(i) £ 27,734 or i.e. £ 27,734 (ii) £ 35,000
This gain of £ 27,734 on t he sale of t he I -Vent ur e Lt d shar es will not be char ged in J anuar y 2007, but will inst ead become char geable when J ones plc sells it s shar es in Risky Business Lt d.
Assume t hat J ones Lt d sells t he shar es in Risky Business f or £ 50,000 in February 2008 (RPI 203.3).
Corporat e Vent uring Scheme 283
The gains ar ising will be:
Risky Business Lt d £ Proceeds 50,000 Less cost (35,000) Less indexat ion 203.3 – 199.00 199.00 x £ 35,000 (756) I ndexed gain 14,244 Add: def er r ed gain on I -Vent ure Lt d shares 27,734 Gain char ged in Febr uar y 2008 £ 41,978
C22.4 Losses on sales of CVS shares
I f a company sells shar es in a qualif ying CVS company and makes a loss on t he sale, once again t he int er act ion wit h t he subst ant ial shar eholdings r ules must be consider ed. I f t he CVS holding qualifies under the substantial shareholdings rules, no capital loss is allowable.
I f however t he holding is not a subst ant ial shar eholding, t her e ar e t wo t hings t he Par a 68 company can do wit h t he capit al loss. I t may: Sch 15 FA2000
(1) set the loss against capital gains in the same accounting period and carry forward any remaining losses; or
(2) deduct t he loss f rom it s other income in the same accounting period and s.573 I CTA 1988 t her eaf t er of any income in t he preceding 12 months.
The second opt ion is similar t o t he r elief given under s.574 f or individuals who invest in qualif ying t r ading companies (essent ially EI S companies).
Any allowable loss is reduced by t he cor por at ion t ax r elief alr eady obt ained.
Illustration 4
Williams plc, a lar ge UK quot ed company, invest ed £ 500,000 in shar es in Or ange Lt d, a qualif ying CVS company, in J une 2006. The holding was not a subst ant ial shar eholding.
I n it s year ended 31 December 2006, Williams plc would have r eceived cor por at ion t ax r elief of :
£ 500,000 x 20% = £ 100,000
Williams plc sold t he Or ange Lt d shares in Sept ember 2007 f or £ 320,000.
284 Principles of Business Taxat ion ‘Finance Act 2006’
As the shares have been sold within 3 years, the CT relief will be withdrawn. A Par a 46 Schedule DVI assessment will be issued f or t he year in which t he relief was Sch 15 FA2000 or iginally given – i.e., t he year ended 31 December 2006. This will have t he ef f ect of increasing t he t ax liabilit y f or t he year ended 31 December 2006 by:
£ 320,000 x 20% = £ 64,000
Williams plc has t her ef or e r eceived t ot al cor por at ion t ax r elief of £ 36,000 (i.e. £ 100,000 or iginally given less £ 64,000 wit hdr awn).
As t he holding was not a subst ant ial shareholding, t he loss on t he sale of t he shar es is calculat ed as f ollows:
£ Proceeds 320,000 Less cost 500,000 Less cor por at ion t ax r elief obt ained (36,000) (464,000) Allowable loss £ (144,000)
Williams plc can elect t o set t his loss against it s ot her pr of it s in t he year ended 31 December 2007. Assuming ot her pr ofit s ar e £ 1.9m, t he cor por at ion t ax comput at ion will be:
£ Prof it s bef or e r elief 1,900,000 Less CVS loss r elief (144,000) PCTCT 1,756,000
CT @ 30% 526,800
Example 1
Regan plc has one wholly owned subsidiar y. I n November 2005, Regan plc subscr ibed f or £ 120,000 of shar es in Wat er man Lt d, an unquot ed t r ading company. This represented an 8% holding in that company. CVS relief was claimed on t he subscr ipt ion.
On 29 December 2006, Regan plc sold it s shar es in Wat er man Lt d f or £ 75,000. I t s r esult s f or t he year ended 31 December 2006 wer e as f ollows:
£ Adj ust ed t r ading pr of it s 148,000 Schedule DI I I 47,000 Gif t aid paid (8,000) Dividend f r om I CI plc 13,500
Assuming all r elevant claims ar e made, calculat e t he PCTCT f or Regan plc f or t he year ended 31 December 2006.
Corporat e Vent uring Scheme 285
C22.5 Anti avoidance
The r elief will be denied if t her e ar e any ar r angement s t hat pr ovide f or a pre- Par a 37 Sch 15 arranged exit or ot her wise pr ovide t he invest or wit h protection against normal FA2000 commercial risks. The shar es must be issued f or commer cial pur poses and not as par t of a scheme or ar r angement whose main pur pose or one of whose main pur poses is t o avoid t ax.
C22.6 Withdrawal of relief other than on sale Par a 47 Sch 15 FA2000 The r elief can be wit hdr awn if t he r equir ement s r elat ing t o t he issuing company or invest ing company have not been met at any t ime dur ing t he qualif icat ion per iod.
Relief given will be wit hdr awn if dur ing a per iod beginning one year bef or e t he shar es ar e issued and ending when t he qualif icat ion per iod ends (per iod of r est r ict ion) t her e is a receipt of value or t he grant of put or call options over the shares.
The wit hdr awal of t he r elief can be avoided by r epaying t he amount r eceived.
C22.7 Claiming the relief
Bef or e t he issue of t he shar es, t he issuing company can apply for advance clearance t hat t he r equir ement s of CVS r elief ot her t han t hose t o be met by t he invest ing company ar e being met .
I f advance clear ance is applied f or , an advance clear ance not ice will be issued within 30 days, or f ur t her inf or mat ion will be called f or , or t he company will be t old t hat t he Revenue ar e not sat isf ied t hat t he issue meet s t he r equir ement s.
Following t he issue, t he issuing company must provide a compliance statement Par a 41&42 t o t he Revenue. The st at ement conf ir ms t hat t he condit ions r elat ing t o t he Sch 15 FA2000 issuing company and t he shar es have been met or ar e being met f or t he t ime being. The Revenue will t hen authorise the issuing company to provide compliance certificates to the investing companies. The invest ing company can claim t he t ax r elief in it s t ax r et ur n once it has a compliance cer t if icat e.
286 Principles of Business Taxat ion ‘Finance Act 2006’
Answer 1
CVS shar es sold wit hin 3 year s – t her ef or e cor por at ion t ax relief will be wit hdr awn by DVI assessment f or y/ e 31.12.05.
Wit hdrawal = £ 75,000 x 20% = £ 15,000
As t he holding is only 8% it is not a subst ant ial shar eholding and so t her e is an allowable loss.
Loss r elief on sale of Wat er man Lt d shar es can be claimed against gener al pr of it s f or t he per iod. Allowable loss is:
£ Proceeds 75,000 Less cost 120,000 Less cor por at ion t ax r elief obt ained (24,000 – 15,000)* (9,000) (111,000) Allowable loss £(36,000)
* Relief given in y/ e 31.12.05 = £ 120,000 x 20% = £ 24,000
The cor por at ion t ax comput at ion will t her ef or e be:
£ Schedule DI 148,000 Schedule DI I I 47,000 195,000 Less: CVS loss r elief (bef or e char ges) (36,000) 159,000 Less char ges on income (8,000) PCTCT 151,000
Corporat e Vent uring Scheme 287
SUMMARY – THE CORPORATE VENTURING SCHEME
Tax r elief at 20% is available wher e a company subscr ibes f or new shar es in a company which sat isf ies t he condit ions of t he Cor por at e Vent ur ing Scheme. The relief is wit hdrawn if t he shares ar e sold wit hin 3 year s.
Capit al gains on sales of CVS shar es not cover ed by t he subst ant ial shar eholdings exempt ion can be def er r ed by r einvest ing in ot her CVS shar es.
Holding
<10% CVS t ax r elief and def er r al of any gain int o ot her CVS shar es only, no subst ant ial shar eholdings exempt ion f or gains
10-30% CVS t ax r elief and any gain cover ed by subst ant ial shar eholdings exempt ion
>30% No CVS tax relief but any gain still covered by substantial shar eholdings exempt ion
Losses on sales of holdings of CVS shar es which ar e not subst ant ial shar eholdings can be set against gener al income.
Ther e ar e ant i avoidance measur es t o pr event guar ant eed exit s.
Relief can be wit hdr awn if t he invest ing company r eceives value f r om t he issuing company.
The issuing company must pr ovide a compliance st at ement t o t he Revenue who will t hen aut hor ise it t o issue a compliance cer t if icat e.
The invest ing company needs a compliance cer tif icat e t o be able t o claim t he relief .
D: Employee Tax Matters
D1: EMPLOYED OR SELF EMPLOYED?
I n t his chapt er you will lear n about t he dist inct ion bet ween employed and self -employed wor ker s including: - t he MI CE test ; - ot her cr it er ia f or det er mining t he st at us of a worker; - t he implicat ions of being employed or self -employed; - t he t hr ee main cases hear d on t his ar ea.
D1.1 Introduction
I n t he next chapt er we shall t ake a look at legislat ion concer ning per sonal ser vice companies. However , t o under st and t hese r ules we must f ir st examine s.48-61 t he dist inct ion bet ween whet her a wor ker is employed or self -employed f or t ax I TEPA 2003 pur poses.
The t ax legislat ion it self does not t ell us whet her a wor ker is employed or self - employed, so t he dist inct ion bet ween t he t wo is based on case law and on Revenue pr act ice.
I n t he vast maj or it y of inst ances it is obvious whet her an individual is an employee or whet her he is in business on his own account as a self -employed t r ader . However t her e is a consider able gr ey ar ea in bet ween t he t wo.
D1.2 The “MICE” test
To dif f erentiate between employed or self -employed, we apply what we call the MICE t est :
Mut ual obligat ions I nt egr at ion Cont r ol Equipment
“M” stands for mutual obligations.
I f a wor ker is an employee, his employer is under an obligat ion t o pr ovide him wit h wor k, and t he employee is under a similar obligat ion t o accept t he wor k and t o per f or m t he t asks delegat ed t o him. However , if a wor ker is self -employed, he will have no guar ant ee of wor k and even if work is of f ered t o him he is under no legal obligat ion t o accept t he wor k of f er ed. The exist ence of any mut ual obligat ion bet ween t he par t ies will usually be obvious f r om any ser vice cont r act bet ween t he t wo par t ies. Employees usually have an employment cont ract which set s out t he t er ms and condit ions under which t hey ar e t o per f or m dut ies f or t heir employer .
Employed or Self Employed? 289
“I” stands for integration.
An employee will be int egr at ed int o t he business of his employer . By t his we mean t hat t he employee will usually have his or her own desk, a designated computer terminal at which t o work, his or her own stationery, access t o normal employee facilities such as t he st af f r est aur ant , and will have unr est r ict ed access t o t he employer pr emises. Employees will also be allowed t o j oin company pension schemes and r eceive invit at ions t o st af f f unct ions such as Chr ist mas par t ies. Cont r ast t his wit h t he posit ion of a self -employed per son, who will not be int egrat ed int o an employer’s business and will not have a desk or a comput er or access t o t he employer pr emises.
“C” st ands f or cont r ol.
I n a t ypical employer / employee r elat ionship, t he employee will exer cise ver y lit t le cont r ol over what he or she does on a day-t o-day basis. An employer will t ypically t ell an employee what t o do, how t o do it and when to do it by. There is typically a mast er / ser vant r elat ionship bet ween an employer and an employee. On t he ot her hand, a self -employed per son will have f ar mor e cont r ol over t he j obs t hat he or she under t akes and t he deadline f or complet ion of t hose j obs.
“E” st ands f or equipment .
When consider ing whet her a wor ker is employed or self -employed, t he Revenue will always look at who pr ovides t he t ools of t he t r ade. An employee is r ar ely r esponsible f or pr oviding his or her own equipment . When we t ur n up f or wor k we expect our employer s t o pr ovide us wit h a comput er , a t elephone, a f ax and some st at ioner y et c. A self -employed per son, on t he ot her hand, will cust omar ily be r esponsible f or pr oviding t he equipment t o enable him t o under t ake t he wor k of f ered.
D1.3 Other criteria
Ther e ar e a f ew ot her cr it er ia t he Revenue will apply in det er mining whet her a wor ker is employed or self -employed. They will look at t he degree of financial risk t aken by t he wor ker . I f t he wor ker has no f inancial r isk, has no oppor t unit y to directly prof it f rom the work undertaken and is not r esponsible f or bear ing any losses incur r ed in t he cour se of his wor k, it is highly likely t hat t hat individual will be an employee. Typically self -employed people ar e genuinely r esponsible f or how t heir business is r un, will r isk capit al in t heir business and will have t o meet any losses which ar ise.
The number of paymasters is also a det er mining f act or . A t ypical employee has one paymast er – he is paid by his employer and no-one else. However , if a wor ker t ypically per f or ms ser vices f or a number of different companies, he is more likely t o be able t o per suade t he Revenue t hat he is self -employed.
Finally, t he ability to provide a substitute has been somet hing t he Revenue have looked at ver y closely when deciding whet her a wor ker is employed or self -
290 Principles of Business Taxat ion ‘Finance Act 2006’
employed. An employee will have no f r eedom t o send along a subst it ut e in his or her place if , f or what ever r eason, t hey ar e unable t o per f or m t heir dut ies. On t he ot her hand, if a self -employed per son has contracted to do a job and is eit her sick or double-booked, t hat self -employed per son will have t he f r eedom t o pr ovide a subst it ut e t o complet e t he j ob in his place.
This was a cr ucial f actor in t he case of Hall v Lor imer. I n t his case t he Cour t , af t er much deliber at ion, concluded t hat a vision mixer was a self -employed per son lar gely because on a handf ul of occasions, he had been able t o pr ovide a subst it ut e t o f ulf il par t icular cont r act s.
When consider ing whet her a wor ker is employed or self -employed, it is impor t ant t o take a “balance of probabilities approach”. This means t hat no individual f act or can be conclusive in it s own r ight . The I nspect or will look at t he f act s and cir cumst ances of each case, apply t he var ious cr it er ia which we have j ust looked at , and, on balance, decide whet her t he wor ker is likely t o be an employee or whet her he is mor e likely t o be self -employed.
The maj or it y of Revenue Tax Of f ices will have a designat ed “st at us” Of f icer whose j ob it is t o look at whet her wor ker s ar e employees or not .
D1.4 Implications
I t is impor t ant t o est ablish why we need t o dist inguish bet ween whet her a wor ker is employed or self -employed. An employee will pay tax under t he employment income r ules on ear nings f r om his employment . A self-employed trader will pay tax on t he pr of it s of his t r ade. The r ules f or det er mining t axable ear nings ar e dif f er ent t o t hose used t o calculat e t r ading pr of it s.
One ar ea wher e t he r ules ar e ver y dif f er ent is concer ning expenses. We know that it is very difficult for an employee to get a deduction for employment expenses. However , t he expenses t est f or t r ader s is f ar less st r ingent and self - employed t r ader s can deduct much mor e by way of expenses t han an employee. For t his r eason, many t axpayer s would r at her be t r eat ed as self -employed t han as employees.
When ear nings ar e paid t o employees, t he employer must account f or t ax at sour ce under PAYE. Employees pay t ax on t heir ear nings as t hey go along. This is not t he case f or self -employed t r aders who will pay t heir t ax on 31 J anuar y and 31 J uly under t he Self Assessment r egime. This can give self -employed t r ader s a consider able cash f low advant age. The dist inct ion is ver y impor t ant f or NI C pur poses. Bot h employees and employer s pay Class 1 NIC on earnings. Employer s pay Class 1A Nat ional I nsur ance on benef it s pr ovided t o t heir employees. Class 1 NI C is a consider able cost f or employer s, so f or NI C pur poses, it is ver y expensive f or a company t o t ake on an employee.
Class 1 NI C does not apply when payment s ar e made t o self -employed t r ader s. Self-employed individuals pay NIC under Class 2 and Class 4. As you will see
Employed or Self Employed? 291
when you st udy t he t axat ion of business income, it is consider ably cheaper f r om an NI C per spect ive f or an individual t o be classed as a self -employed per son.
Employees will t ypically have t he right t o j oin an Occupational Pension Scheme pr ovided by t heir employer . Self-employed persons ar e not allowed t o make payment s int o Company Pension Schemes. I f t hey wish t o make pension pr ovision, t hey must do so via a Personal Pension Scheme or a Stakeholder Scheme. We shall look at pensions in a lat er chapt er .
One maj or consolat ion f or employees is t hat t hey do not have t o wor r y about VAT. A self-employed trader will have to register with Customs & Excise for VAT pur poses once his t ur nover has exceeded a cer t ain level. VAT r egulat ions place a consider able administ r at ive bur den on self -employed t axpayer s.
Finally, employees ar e protected by the Employment Protection Acts. For example, most employees will be entitled to sick pay, holiday pay, and maternity leave and will have t he r ight not t o be unf air ly or wr ongf ully dismissed. On t he ot her hand, self -employed per sons are not cover ed by t he Employment Prot ect ion legislat ion and will not have t he same r ight s as employees.
For inst ance, if a company chooses t o dispense wit h t he ser vices of a self - employed per son – per haps because t hey have f ound somebody else who will do t he same j ob at a lower pr ice - t he self-employed t r ader will usually have no legal redress. He will simply have to accept it as part and parcel of the day to day business of a self -employed t r ader .
However , incr easingly legislat ion gives r ight s and obligat ions t o “wor ker s”, f or example under t he Wor king Time Dir ect ive and t he Nat ional Minimum Wage Act 1998. Some individuals who ar e self -employed could have such st at ut or y pr ot ect ion.
I n summar y t he main dif f er ences ar e:
Employees Self Employed
Employment income Tr ading income Tough expenses t est Easier expenses t est PAYE Self assessment Class 1 NI C (expensive) Class 2 and 4 NI C (cheaper ) Occupat ional pension Per sonal pension No VAT r equir ement s VAT r egist r at ion Employment law pr ot ect ion Less legal pr ot ect ion
D1.5 Case Law
As t he cr it er ia t o det er mine employed v self -employed have been lar gely built up over t he year s in t he Cour t s, it is impor t ant t hat you ar e f amiliar wit h t he leading t ax cases in t his ar ea. I n t his session we shall look at t hr ee t ax cases.
Fall v Hitchen (1973)
292 Principles of Business Taxat ion ‘Finance Act 2006’
This case concer ned a pr of essional dancer . The dancer wor ked f or a t heat r e company under a st andar d cont r act appr oved by Equit y, which is t he Brit ish Act or s Union. Under t he cont r act t he dancer would at t end r ehear sals and per f or mances over a per iod of ar ound f ive t o six mont hs and eit her par t y could t er minat e t he agr eement by t wo weeks wr it t en not ice.
The dancer wor ked specif ied hour s and r eceived a f ixed salar y paid at r egular int er vals. The dancer was pr ovided wit h st age cost umes and was per mit t ed by t he t heat r e company t o seek wor k elsewhere in t imes when he was not needed.
The dancer ar gued t hat he was self -employed and should t her ef or e be assessed on t r ading income. However t he Cour t s rej ect ed t his claim and held t hat his cont r act was a cont r act of ser vice. As such, he was t reat ed as an employee and any income was assessed on employment income. Following Fall v Hit chen, t he Revenue assessed all act or s engaged under st andar d Equit y cont r act s as employees.
However , since 1993, it has been agr eed t hat actors in general should be treated as self-employed individuals r at her t han employees engaged in a succession of employment s. However on occasions wher e an act or is engaged in r egular wor k, f or a f ixed salar y f or a par t icular employer , t he Revenue will r egar d t hat cont r act as a cont r act of ser vice and char ge any income under t he employment income r ules. This will be t he case f or act or s who r egular ly appear on our scr eens in soap oper as et c, as t hey per f or m ser vices f or a r egular salar y f or one pr oduct ion company in a specif ied r ole.
Market Investigations v Minister of Social Security (1969) This case involved a mar ket r esear cher who wor ked as a par t -t ime int er viewer f or a mar ket r esear ch company. Her j ob was t o ask pr e-set quest ions devised by t he mar ket r esear ch company t o member s of t he public. The market r esear cher had lit t le or no cont r ol over what she did on a day t o day basis – she was t old what t o do and how t o do it . I n addit ion, any equipment necessar y f or t he j ob was pr ovided by t he mar ket r esear ch company.
The case was br ought t o t he Cour t s by t he Depar t ment of Social Secur it y who successf ully ar gued t hat t he wor ker should be t r eat ed as an employee f or NI C pur poses. As such, any ear nings paid wer e subj ect t o Class 1 pr imar y and Class 1 secondar y Nat ional I nsur ance Cont r ibut ions.
Subsequent t ax cases on t he subj ect of employed ver sus self -employed have made r ef er ence t o t he J udge’s summar y in t he Mar ket I nvest igat ions case.
I n his summing up, t he J udge made r ef er ence t o t he use of t he var ious cr it er ia we have alr eady looked at , such as t he pr ovision of equipment , t he abilit y t o hir e a helper , and t he degr ee of cont r ol and f inancial r isk et c.
I n t his par t icular case, t he J udge f ound t hat t he mar ket r esear cher was not in business on her own account and could not t her ef or e be r egar ded as a self - employed individual.
Hall v Lorimer (1993)
Employed or Self Employed? 293
Mr Lor imer was a vision mixer who wor ked f or a number of dif f er ent t elevision companies. His wor k involved him under t aking a ser ies of shor t -t er m cont r act s t ypically of one t o t wo days each. Mr Lor imer wor ked f or a number of dif f er ent pr oduct ion companies, and over a t hr ee or f our year per iod in t he 1980s he r eceived income f r om about 20 dif f er ent companies.
Mr Lor imer ’s wor k was always under t aken on company pr emises using equipment pr ovided by t he st udio company. This was lar gely due t o t he specialist nat ur e of t he wor k. Mr Lor imer issued t he pr oduct ion company wit h an invoice af t er each j ob and was r egist er ed f or VAT pur poses. Mr Lor imer was r esponsible f or making good his own losses and r an t he r isk of incurring bad debts. To guard against losses he had an insur ance policy which cover ed him in t he event of sickness. Dur ing t he per iod in quest ion, Mr Lor imer was unable t o f ulf il his obligat ions on a handf ul of cont r act s and in his place he pr ovided a subst it ut e wor ker .
The Revenue ar gued t hat Mr Lor imer had a ser ies of employment s and hence should be t axed on employment income. They put par t icular emphasis on t he f act t hat Mr Lor imer wor ked on st udio premises using st udio equipment .
However , bot h t he High Cour t and t he Court of Appeal agr eed t hat Mr Lor imer was self-employed. The Cour t s comment ed t hat it was impor t ant t o look at all t he r elevant cr it er ia and t o make a j udgement based on an evaluat ion of all t he f act or s r at her t han one or t wo in par t icular .
However , t he Cour t s wer e par t icular ly swayed by t he f act t hat Mr Lorimer could, and indeed did, hire a helper to assist him in t he per f or mance of his dut ies and t his abilit y t o pr ovide a subst it ut e is not an opt ion t ypically available t o an employee.
294 Principles of Business Taxat ion ‘Finance Act 2006’
SUMMARY - EMPLOYED OR SELF EMPLOYED?
To dif f er ent iat e bet ween employed or self -employed wor ker s, we apply t he MI CE t est :
Mut ual obligat ions I nt egr at ion Cont r ol Equipment
Ot her crit eria used include:
Degr ee of f inancial r isk Number of paymast er s Abilit y t o pr ovide a subst it ut e
All t he cr it er ia must be consider ed r at her t hen one f act or being conclusive.
The main dif f er ence bet ween employed and self -employed wor ker s ar e summar ised below:
Employees Self Employed Employment income Tr ading income Tough expenses t est Easier expenses t est PAYE Self assessment Class 1 NI C (expensive) Class 2 and 4 NI C (cheaper ) Occupat ional pension Per sonal pension No VAT r equir ement s VAT r egist r at ion Employment law pr ot ect ion Less legal pr ot ect ion
The leading t ax cases in t his ar ea ar e Fall v Hit chen (dancer held t o be an employee as his cont r act was a cont r act of ser vice), Mar ket I nvest igat ions Lt d (mar ket r esear cher held t o be an employee as she was not in business on her account ) and Hall v Lor imer (vision mixer held t o be self -employed as he could and had pr ovided a subst it ut e).
D2: INTRODUCTION TO EMPLOYMENT INCOME & BENEFITS
I n t his chapt er you will lear n t he basic principles of t axat ion of income f r om employment including: - what const it ut es employment income; - t he def init ion of “earnings” and “emolument s”; - r eceipt s basis; - what a t axable benef it is; - concept of cash equivalent ; - t he case of Pepper v Har t ; - lower paid employees.
Ref er ences in t his chapt er ar e t o t he I ncome Tax (Ear nings & Pensions) Act 2003 unless st at ed ot her wise.
D2.1 Employment Income
The I ncome Tax (Ear nings & Pensions) Act (I TEPA) 2003 t axes income f rom
employment as well as ot her income such as t hat f r om pensions and from
certain social security benefits. An “employment” in this cont ext includes any s.4 employment under a cont r act of ser vice as well as appr ent iceships and ser vices f or t he Crown. Employment s also cover “of f ice holder s” such as dir ect or s. The s.5 Act simply r ef er s t o all employees and dir ect or s as “employees”.
Employment income gener ally f alls under t wo main cat egor ies – t hese ar e s.6 “general earnings” and “specific employment income”.
“Gener al ear nings” ar e t he most pr evalent and consist of r emuner at ion paid in s.7(3) normal monetary form – i.e. cash – as well as cer t ain non-monetary rewards such as t axable benef it s. The def init ion of “gener al ear nings” ext ends t o cer t ain ot her payment s such as sick pay, payment s t o non-appr oved pension schemes and payment s f or r est r ict ive covenant s. I n essence, “gener al ear nings” cover s payment s made t o t he employee as a reward for services rendered.
“Specif ic employment income” br oadly cover s payment s made t o t he employee by s.7(4) his employer which ar e not part of the usual remuneration package and is def ined as “any amount which counts as employment income excluding any exempt income”. We shall deal wit h exempt income in lat er chapt er s.
I ncome which “count s as employment income” is divided int o t hr ee being: s.7(6)
a) income which is not ear nings or “shar e r elat ed”; b) “shar e r elat ed income; or c) any ot her enact ment (i.e. employment income which is t axable but which doesn’t “f it ” any of t he ot her cat egor ies).
“Non-shar e r elat ed” income br oadly encompasses termination payments and employer cont r ibut ions t o non-appr oved pension schemes.
296 Principles of Business Taxat ion ‘Finance Act 2006’
“Shar e r elat ed” income cover s pr of it s and gains made by employees f r om var ious share option and share incentive schemes of f er ed by t he employer .
We will deal wit h each of t hese in lat er chapt er s.
D2.2 Definition of “earnings”
“Ear nings” ar e def ined wit hin s.62 I TEPA 2003 as: s.62
a) any salar y, wages or f ee; b) any gr at uit y or ot her pr of it or incident al benef it of any kind obt ained by t he employee if it is money or money’s wor t h; c) anyt hing else t hat const it ut es an emolument of t he employment .
Br oadly speaking, “ear nings” ar e cash remuneration or any f or m of payment of direct monetary value, or which can be converted into cash. This will cover obvious f or ms of payment such as salar ies and bonuses, but will also cover tips and gratuities r eceived in t he cour se of car r ying out one’s employment dut ies or payments in the form of cash vouchers or premium bonds which can be sur r ender ed f or cash.
The def init ion of “ear nings” does not specif ically cover benef it s in kind (eg company car s, cheap loans, living accommodat ion, et c.) as such r emuner at ion is neit her cash nor of dir ect monet ar y value. However , t he pr ovision of such benef it s is br ought wit hin t he char ge t o income t ax by t he “Benef it s Code”. We shall look at benef it s in det ail in lat er chapt er s.
D2.3 “Emoluments” of the employment
Ther e is a signif icant body of case law t o det er mine t he exist ence of an s.62 “emolument” of an employment . This t er m was par t of t he old st at ut or y pr ovisions and was specif ically r et ained in I TEPA 2003 t o ensur e t hat t he case law was st ill applicable.
“Emolument s of an employment ” ar e char geable t o t ax under s.62. The key wor ds her e ar e “of the employment”. J ust because a payment is made by an employer t o an employee, it does not aut omat ically f ollow t hat t he payment is f r om t he “employment ”.
For a payment t o be t r eat ed as being “fr om an employment ”, t he payment must gener ally be made in return for services (past , pr esent or f ut ur e).
I n Hochst r asser v Mayes (1959), an employee (wor king f or I CI plc) was r elocat ed t o anot her par t of t he UK. The employee had t o sell his house and r eceived compensat ion f r om his employer f or t he loss on sale. The quest ion ar ose as t o whet her such compensat ion was an emolument f r om t he employment .
I nt r oduct ion t o Employment I ncome & Benef it s 297
I n t heir j udgement t he House of Lor ds st at ed t hat
“…if it is t o be t he subject of an assessment , it must ar ise from the employment. I t is not suf f icient t o r ender a payment assessable t hat an employee would not have r eceived it unless he had been an employee …it is assessable if it has been paid t o him in r et ur n f or act ing or being an employee”.
The Lor ds held t hat t he compensat ion payment was made t o t he individual in his capacit y as a homeowner r at her t han “in r et ur n f or act ing or being an employee”. As t he payment was not made by r ef er ence t o any ser vices per f or med, it was not an emolument of t he employment .
[Not e: t his was a 1959 case and such payment s ar e now dealt wit h under s.271 t o s.289 concer ning r emoval expenses].
To illust r at e t he subt le complexit ies of case law, a dif f er ent decision was ar r ived at in t he case of Hamblet t v Godf r ey (1987). I n t his case, an employee of a gover nment agency (GCHQ in Chelt enham) was of f er ed £ 1,000 as compensation for agreeing to give up her rights to join a trade union. The employee cont ended (cit ing Hochst r asser v Mayes) t hat t he payment was not an emolument f r om her employment as it was not being made in r et ur n f or ser vices.
I n t his case t he Cour t s disagr eed and f ound t he payment t o be a t axable emolument . The r ight t o j oin a t rade union is par t and par cel of “acting or being an employee”. The payment was t oo closely linked t o t he employer –employee r elat ionship f or it t o be t r eat ed as anyt hing ot her t han an emolument .
I n Shilt on v Wilmshur st (1991), a f oot baller (England goalkeeper Pet er Shilt on) t r ansf er r ed f r om Not t ingham For est t o Sout hampt on f oot ball club. As t he player was under cont r act t o Not t ingham For est , t he club agr eed t o pay Mr Shilt on £ 75,000 t o agr ee t o t he t r ansf er . Again t he quest ion ar ose as t o whet her t his payment ar ose “f r om t he employment ”.
Mr Shilt on cont ended t hat t he payment was made t o him by his f or mer employer in connect ion wit h t he t er minat ion of his employment (such t er minat ion payment s being t ax f r ee up t o £ 30,000). The Revenue ar gued t hat t he payment was a r ewar d or inducement f lowing f r om t he ser vices he was about t o of f er t o Sout hampt on FC.
The Cour t s agr eed wit h t he Revenue and f ound t he payment t o have ar isen from Mr Shilton’s employment (t heref ore f ully t axable). Mr Shilt on had received payment “to remain or become an employee” – t he payment was t o induce t he player t o become an employee of Southampt on FC and f or no ot her r eason.
Similarly in Glant r e Engineer ing Lt d v Goodhand (1983), an inducement payment t o per suade an account ant t o leave Er nst & Young (as is now) and j oin a small engineer ing f ir m was held t o be an emolument as it was paid by r ef er ence t o ser vices “t o be per f or med” f or t he new company.
298 Principles of Business Taxat ion ‘Finance Act 2006’
I n Mair s v Haughey (1993), an employee moved f r om a gover nment owned company t o a new pr ivat e company, and in r et ur n f or accept ing t he new employment he r eceived t he f ollowing:
(i) £ 4,506 paid by t he gover nment owned company as compensat ion f or t he employee giving up his r ight s under t heir r edundancy scheme; and (ii) £ 1,300 f r om t he new company as an “ex gr at ia” incent ive t o j oin.
The Cour t s held t hat t he lat t er was t axable being an inducement payment r ef er able t o ser vices t o be per f or med. However , compensat ion payment s f or loss of r edundancy r ight s wer e not wit hin t he def init ion of an emolument .
D2.4 Amount of employment income charged to tax
S.9 I TEPA 2003 deals wit h how much of a t axpayer ’s income is char geable t o s.9 income t ax f or a par t icular t ax year .
I n t he case of “gener al ear nings”, t he amount char ged t o t ax is t he “net taxable s.11 earnings” f r om t he employment in t he t ax year . “Net t axable ear nings” ar e “t axable ear nings” less any deductions allowed from those earnings under t he “expenses pr ovisions” wit hin t he Act . Essent ially employees r eceive t ax r elief in r espect of any expenses “wholly, exclusively and necessarily” incur r ed in doing t heir j ob. We shall look specif ically at employment expenses in a lat er chapt er .
Net t axable ear nings can t her ef or e be br oadly summar ised as:
£ £ Cash r emuner at ion: Salar y, bonus et c X Ot her emolument s which have dir ect monet ar y value X Non cash r emuner at ion: Benef it s X Less: exempt income (X) Taxable ear nings X Less: allowable deduct ions: Employment expenses X Ot her deduct ions (X) NET TAXABLE EARNINGS X
D2.5 The “receipts” basis
S.15 I TEPA 2003 deals wit h gener al ear nings (cash plus benef it s) of an s.15 employee r esident or dinar ily r esident and domiciled in t he UK and t ells us t hat …
“The full amount of any earnings …which are received in a t ax year is an amount of “taxable earnings” f r om t he employment in t hat t ax year ”.
I nt r oduct ion t o Employment I ncome & Benef it s 299
Ther ef or e t he way we t ax an individual’s employment income is on a “receipts basis”. This means t hat employees and direct ors will be t axed on t heir employment income when it is received.
The r ules f or t axing ear nings ar e slight ly dif f er ent f or employees who ar e eit her r esident , or or dinar ily r esident or domiciled out side t he UK, and t hese will be cover ed in a lat er session.
The dat e of r eceipt of ear nings consist ing of money is t he ear lier of t wo dat es: s. 18 1) t he t ime when payment is made Rule 1 2) t he t ime when a per son becomes entitled to payment Rule 2
Ther ef or e if an employee or dir ect or becomes ent it led t o a payment bef or e he or she is physically paid t he money, t he dat e of ent it lement is t r eat ed as t he dat e of r eceipt and t he payment is t axed at t hat point . I n pr act ice t his dist inct ion is not par t icular ly impor t ant , as f or most of us t he dat e of ent it lement and t he dat e of physical r eceipt ar e usually t he same.
Wher e t he r eceipt s basis becomes impor t ant is wit h r egar d t o t he t axat ion of bonuses. Consider a company which dr aws up account s f or t he year ended 31 December 2005. On t he 28 April 2006, t he annual gener al meet ing is held and t he boar d of dir ect or s of t he company sign of f t he account s and agr ee t he pr of it s of t he year j ust ended. At t his point t he company ar e in a posit ion t o det er mine t he bonuses due t o t heir employees.
An employee r eceives a bonus at t he end of April 2006 in respect of work carried out by him in t he year which ended in December 2005. For employment income pur poses, t he employee is t axed on his bonus not in t he per iod in which t he bonus was ear ned, but inst ead on the date the bonus is physically received.
As such t his bonus is t axable at t he end of Apr il 2006, and t her ef or e goes int o t he employee’s t ax comput at ion f or t he 2006/ 07 t ax year .
This is a gener al pr inciple and t her e ar e always occasional except ions. Cer t ain special rules exist for company directors but in most cases t he nor mal r eceipt s basis will apply.
I n r elat ion t o company dir ect or s, t he dat e of r eceipt is t he ear liest of eit her of s.18 t he above t wo dat es, and; Rule 3 when sums on account of his ear nings ar e credited in t he company account s; or at the end of t he company’s account ing per iod if t he ear nings have been det er mined by the end of t hat period; or at t he dat e t he ear nings ar e determined if that date f alls after t he end of t he company’s account ing per iod.
300 Principles of Business Taxat ion ‘Finance Act 2006’
Illustration 1
Mr Mat t hews is a company dir ect or ear ning £ 60,000 per annum. He is ent it led t o an annual bonus based on t he company’s r esult s f or each year ending on 31 December .
At t heir Board Meet ing on 25 March 2007, t he Board agr ee t he dr af t account s and det er mine Mr Mat t hews’ bonus in t he sum of £ 25,000. This is paid t o Mr Mat t hews on 30 April 2007.
Alt hough t he dat e of physical r eceipt is 30 April 2007, as Mr Mat t hews is a dir ect or , we need t o consider Rule 3 in s.18 I TEPA 2003. Mr Mat t hews’ ear nings wer e det er mined af t er t he end of t he company’s account ing per iod, t her ef or e r ule (c) above applies. The dat e of “r eceipt ” f or employment income pur poses is t heref ore 25 March 2007 and t he bonus will be t axable in 2006/ 07.
D2.6 Taxable benefits
Benefits are very important as f ar as your exam is concerned. By benefits we s.63 mean non-cash r emuner at ion. Many employees r eceive such benef it s as par t of t heir over all r emuner at ion package.
These benef it s of t en include t he use of a company car, t he use of company pr ovided accommodation, or a cheap loan. Private medical insurance or cont r ibut ions by t he employer t o t he employee’s pension scheme ar e also ver y common benef it s, as is t he pr ovision of a mobile phone along wit h associat ed t elephone calls. The maj or it y of t hese benef it s ar e t axable in t he hands of t he employee. Ther e ar e cer t ain benef it s which ar e exempt f r om t ax and we shall deal wit h t hese lat er .
For t axable benef it s, we need t o det er mine t he “cash equivalent” of each par t icular benef it . Essent ially we ar e allocat ing a cash f igur e t o each t axable benef it and t her eaf t er we will t ax t hat cash equivalent as if it was an addit ional amount of ear nings.
I nt r oduct ion t o Employment I ncome & Benef it s 301
D2.7 Measuring the benefit
Benef it s ar e char geable t o t ax if t hey ar e eit her :
(i) specif ically char ged wit hin t he Benef it s Code; or (ii) “employment -r elat ed” benef it s under s.201 onwar ds I TEPA 2003.
We shall look at specif ic benef it s wit hin t he Benef it s Code in lat er sessions, but f ir st we will examine t he r ules f or t axing employment related benefits.
An employment r elat ed benef it is a benef it pr ovided eit her f or an employee, or s.201 f or a member of t he employee’s family or household, by r eason of t he employee’s employment . Ther ef or e, a t axpayer cannot avoid being t axed on t he pr ovision of a benef it simply by dir ect ing his employer t o pr ovide t he benef it t o, say, his wif e r at her t han himself .
This means, f or example, if by reason of Jack’s employment, Jack’s wif e or son ar e pr ovided wit h a company car or ot her benef it , it is Jack who will be char ged t o income t ax on t he cash equivalent of t hat benef it .
S.203 I TEPA 2003 t ells us t hat “t he cash equivalent of an employment r elat ed s.203 benef it is to be treated as earnings f r om t he employment f or t he t ax year in which it is pr ovided”, and ..
“The cash equivalent of an employment -r elat ed benef it is t he cost of the benefit less any part of that cost made good by the employee t o t he per sons pr oviding t hat benef it ”.
Under s.204 I TEPA 2003, “t he cost of an employment r elat ed benef it is t he s.204 expense incurred in, or in connection with, the provision of that benef it”.
This means t hat , f or example, if an employer wishes t o pr ovide a benef it t o an employee in t he f or m of , say, pr ivat e medical insur ance, and t he cost t o t he employer of paying t he pr emium is £ 500, t he cash equivalent – i.e. t he amount charged to tax – is £ 500. The f act that it might cost t he employee mor e t han £ 500 t o obt ain t he same level of medical cover is ir r elevant – we simply look at what it cost the employer to provide the benefit.
Amount s paid by the employee t o t he employer t owar ds t he pr ovision of t he benef it can be deducted f r om t he cash equivalent . Ther ef or e if t he employee r eimbur ses t he employer ’s f ull cost , t he t axable benef it will be zer o.
Ever y benef it pr ovided by an employer t o an employee which has a cash equivalent , must be reported to the Revenue by t he employer on a special form called a P11D. The employer should complet e a f or m P11D f or each employee who has r eceived t axable benef it s, and t hese f or ms should be submitted t o t he Revenue no later than 6 July after the end of the tax year. The P11D tells t he Revenue t he amount of t he cash equivalent of each benefit. A copy is given t o t he employee t o enable him t o complet e his own t ax r et ur n.
302 Principles of Business Taxat ion ‘Finance Act 2006’
I n t he case of cer t ain benef it s, it is very dif f icult t o est ablish exact ly what is t he cost t o t he employer of pr oviding t he benef it . I n such cases special r ules exist t o help us calculat e t he cash equivalent . Special r ules ar e in place f or calculat ing company car and f uel benef it s, accommodat ion benef it s, cheap loans and inst ances wher e an employer lends an asset t o an employee. We shall t ake a look at t hese var ious special r ules lat er .
D2.8 Pepper v Hart
The concept of t he “cost of providing” a benef it was t he subj ect of a leading and ext r emely impor t ant t ax case hear d by t he House of Lor ds in 1993. The case of Pepper v Hart concer ned a pr ivat e, f ee-paying school. J ust bef or e t he st ar t of t er m, t he school had some sur plus places, which it had been unable t o sell. The school t her ef or e allowed some of t he schoolmasters t o send their own children to the school t o be educat ed at a subsidised price.
The Revenue and t he schoolmast er s bot h agr eed t hat a benef it had ar isen. This was because an employee or member s of his f amily or household wer e being pr ovided wit h a benef it (i.e. cheap educat ion) by r eason of t he schoolmast er s’ employment . Ther e was no disput e t hat a benef it had ar isen.
The ar gument was about how t o det er mine t he “cost t o t he employer ” in pr oviding t he educat ion t o t he childr en involved. Each side put f or war d an alt er nat ive way of est ablishing t he cost t o t he school of pr oviding t he benef it .
The Revenue ar gued t hat we should f ir st t ake t he t ot al cost of r unning t he school f or t he year . This f igur e should t hen be divided by t he number of pupils in t he school t o give an aver age cost of providing educat ion per st udent . Fr om t his aver age cost , we deduct t he f ees act ually paid by t he schoolmast er s and t he dif f er ence is t he t axable benef it . The Revenue t her ef or e argued that “cost of providing” as per t he legislat ion actually meant the “average” cost.
The t axpayer put f or war d an alt er nat ive suggest ion. He ar gued t hat we f ir st calculat e t he cost of r unning t he school f or it s normal fee paying pupils (i.e. not count ing t hose st udent s r eceiving subsidised educat ion). Next we calculat e t he cost of r unning t he school f or all the pupils, t his t ime including t he addit ional childr en who had paid r educed f ees. The difference bet ween t hese t wo f igur es is t he addit ional cost incurred by t he school in pr oviding t hese ext r a places.
Ther ef or e t he cost of pr oviding each addit ional place is t his f igur e divided by t he number of ext r a places. Fr om t his we deduct t he f ees paid by t he schoolmast er s and t he dif f er ence is t he t axable benef it . What t he taxpayer was advocat ing was a “marginal” cost method as opposed t o t he Revenue’s aver age cost met hod.
The House of Lor ds on a maj or it y decision f ound in f avour of t he taxpayer and decided t hat t he marginal cost method was t he cor r ect way of calculat ing t he cash equivalent in t his inst ance.
I nt r oduct ion t o Employment I ncome & Benef it s 303
The case of Pepper v Har t has par t icular r elevance when it comes t o calculat ing t he benef it in r espect of “in-house benefits” as we shall now illust r at e.
Illustration 2
A f light is about t o leave f r om London Heat hr ow air por t t o J FK New Yor k. The f light will cost t he airline £ 20,000. The plane has 100 seat s. This means t hat t he aver age cost t o t he air line is £ 200 per seat . Assume t hat all but one of t he seat s have been sold t o nor mal f ee paying passenger s. A f ew minut es bef or e t he f light is due t o leave, t he air line of f er s t his spar e seat t o one of it s employees f or t he bar gain pr ice of £ 10.
Ther e is a benef it ar ising t o t he employee because t he employee is r eceiving a benef it – i.e. a ver y cheap f light – by r eason of his or her employment . The cash equivalent will be t he cost t o t he air line of pr oviding t hat one heavily subsidised seat t o one if it s employees.
Following Pepper v Har t we do not t ake t he aver age cost per passenger of £ 200. I nst ead we consider t he mar ginal cost . This will be t he ext ra cost t o t he airline of f lying t hat one ext r a passenger over t o New Yor k.
This ext r a cost should be negligible – pr esumably it cost s mor e or less t he same to fly 100 passengers to New York as it does to fly 99. There will be a few addit ional cost s such as one ext r a in-f light meal or an ext r a newspaper which should be cover ed by t he £ 10 paid by t he employee.
As a r esult f ollowing t he pr inciple est ablished by Pepper v Har t , wher e an employee is using goods or ser vices manuf act ur ed or pr ovided by his employer , t he mar ginal cost is ef f ect ively zer o giving r ise t o a t axable benef it of nil.
D2.9 Lower paid employees s.216
Cer t ain chapt er s of t he Benef it s Code do not apply if t hose benef it s ar e pr ovided t o an employee who def ined as a lower paid employee and who is not a director of a company. These excluded benef it s include company car s and vans, cheap loans, cer t ain shar e r elat ed benef it s and cer t ain expenses payment s.
A lower paid employee is one ear ning less t han £ 8,500 in t he t ax year .
I n or der t o est ablish whet her an employee ear ns mor e or less t han £ 8,500, we s.217 need t o t ake account of cash earnings (including expense r eimbur sement s) and any payment s treated as earnings, f or example under t he Benefits Code. We also need t o add in any amount s r eceived under t he special r ules f or int er mediar ies (see Chapt er 27). We t hen need t o deduct “aut hor ised deduct ions” as list ed in s.217(4) which include payr oll giving and cer t ain pension cont r ibut ions:
304 Principles of Business Taxat ion ‘Finance Act 2006’
£ Cash ear nings (including X r eimbur sed expenses) Payment s t r eat ed as X ear nings (eg Benef it s) Ear nings f r om X int er mediar ies X Less: aut hor ised (X) deduct ions TEST HERE X
Not e t hat f or t he pur poses of t he t est , we include expense r eimbur sement s but do not deduct gener al business expenses (eg t r avel et c) which ar e allowable under t he expenses r ules as t hese ar e not in t he list of aut hor ised deduct ions.
I f t he r esult ing f igur e at t he bot t om is £ 8,500 or mor e, we do not have a lower paid employee. In this instance, all benef it s and expenses payment s will be t axed in t he nor mal way. The above t est is designed in t his way t o pr event a company paying an employee a cash salar y of £ 8,499 and “t opping-up” his r emuner at ion package wit h a number of non-cash benef it s and expenses.
I f an employee is a lower paid employee, t axable benef it s will st ill need t o be r epor t ed t o t he Revenue but t his t ime on a f or m P9D as opposed t o f or m P11D.
I t is mor e common f or an employer t o pr ovide benef it s t o employees who ar e not lower paid employees nor dir ect or s, and we will concent r at e on t hese f or t he r est of t his cour se.
D2.10 Pension income and social security income
Part s 9 and 10 of I TEPA 2003 deal wit h t he t axat ion of pension income and social secur it y income.
I ncome f r om pensions is gener ally t axable. This will include t he St at e Pension and any pension income paid by a f or mer employer whet her in t he UK or abr oad.
I f a t axpayer is r esident and domiciled in t he UK and r eceives income f r om an s. 65(2) over seas pension, only 90% of t he pension income ar ising is t axable. This “10% I CTA 1988
deduct ion” r ule also applies t o over seas gover nment pensions paid in t he UK. s.617
Many social security benefits paid to UK taxpayers are exempt from tax. Such s.677 exempt sour ces include ber eavement payment s, child benef it , council t ax benef it ,
housing benef it , disabilit y living allowances and t he new wor king t ax cr edit s and child t ax credit s.
Ther e ar e however , st ill a signif icant number of social secur it y benef it s which ar e s.660 t axable under I TEPA 2003. These include incapacit y benef it , income suppor t , j ob seeker s allowances, st at ut or y mat er nit y pay and st at ut or y sick pay.
I nt r oduct ion t o Employment I ncome & Benef it s 305
Example 1
Br uno wor ks f or Online Tut or s Limit ed (OTL). Which of t he f ollowing are t axable under I TEPA 2003?
a) Salary b) Per f or mance Relat ed Bonus c) M&S voucher f r om employer d) Dividend on shar es in OTL e) I nt er est f r ee loan f r om OTL f) Prof it f r om one-of f consult ing j ob f or a local business
Example 2
Chr is and Dean wor k f or Online Tut or s Limit ed. Their ear nings ar e as f ollows:
Chr is Dean £ £ Salary 6,000 5,000 Bonus 1,000 Nil Benef it s (cash equivalent ) 1,400 2,800 Business expenses r eimbur sed 200 600
Which of t hem is a lower paid employee?
a) Chris only b) Dean only c) Bot h of t hem d) Neither of them
306 Principles of Business Taxat ion ‘Finance Act 2006’
Answer 1
Employment income? a) Salary b) Per f or mance Relat ed Bonus c) M&S voucher f r om employer d) Dividend on shar es in OTL X (Dividend income) e) I nt er est f r ee loan f r om OTL f) Prof it f r om one-of f j ob X (Miscellaneous income)
Answer 2
The answer is B
Chris Dean
£ £ Salary 6,000 5,000 Bonus 1,000 Nil Benef it s 1,400 2,800 Expenses 200 600 TEST 8,600 8,400
“Lower paid” NO YES
Dean would t her ef or e not be t axable on t he benef it s.
I nt r oduct ion t o Employment I ncome & Benef it s 307
SUMMARY - EMPLOYMENT INCOME & BENEFITS
The I ncome Tax (Ear nings & Pensions) Act 2003 t axes income f r om employment including cash and non-cash r emuner at ion. I t also t axes pensions r eceived, t er minat ion payment s and pr of it s on shar e opt ions.
The r eceipt s basis applies so a bonus is t axed when r eceived, not when ear ned.
Non-cash benef it s ar e also t axable. Their cash equivalent is equal t o t he cost t o t he employer in pr oviding t he benef it and is r educed by any cont r ibut ion made by t he employee. Benef it s ar e r epor t ed on t he P11D due by 6 J uly f ollowing t he t ax year .
The case of Pepper v Har t est ablished t he pr inciple t hat cost t o t he employer should be mar ginal cost .
Lower paid employees ear ning < £ 8,500 p.a. who ar e not dir ect or s ar e not t axable on some benef it s.
D3: COMPANY CAR & FUEL BENEFITS
I n t his chapt er you will lear n t he r ules f or t he t axat ion of company car and f uel benef it s including: - how t o f ind list price;
- how t he cash equivalent is based on CO2 emissions; - non availabilit y; - f uel benef it .
All st at ut or y r ef er ences ar e t o I TEPA 2003 unless st at ed ot her wise.
D3.1 Introduction
One of t he most common benef it s of f er ed by employer s t o t heir employee is s.114 - t he pr ovision of a company car and f uel f or pr ivat e mot or ing. s.172
I f a car is pr ovided t o a lower paid employee who is not a dir ect or , the benefit s.216(4) is tax free.
For ot her employees, special r ules exist t o enable us t o calculat e t he cash equivalent on t he pr ovision of a company car . I f a car is made available by an employee f or t he exclusive use of a par t icular employee, it doesn’t mat t er s.120 & whet her t he car is owned by t he employer or leased by t he employer f r om a s.121 third party, the employee will have a taxable benefit in respect of the private use of the car. The cash equivalent depends on a number of f act or s.
The st ar t ing point in calculat ing car benef it s is t he list price of t he car when it s.122 is f ir st r egist er ed (i.e. when br and new). This is not necessar ily t he same as t he pr ice act ually paid by t he employer f or t he car .
The cash equivalent also depends on t he vehicle’s carbon dioxide (CO2) s. 139 emissions. Essent ially, t he lower the emissions, the lower the benefit. This is an at t empt by t he gover nment t o be r esponsible wit h r egar d t o t he pr ot ect ion
of t he envir onment .
Also t he benef it depends on whether the car was available for the whole of s.143 the year. As is t he case wit h most benef it s, if t he employee does not have t he benef it f or t he whole of t he year , we need t o do an appor t ionment t o ar r ive at
t he cash equivalent .
Lat er on in t his chapt er we will look at t he separ at e benef it t hat ar ises when an s.149 employer pr ovides t he employee wit h f uel f or his or her pr ivat e mot or ing.
Company Car & Fuel Benef it s 309
D3.2 List price
We will now put all of t hese var iables t oget her int o a company car pr of or ma: £ List pr ice when new A Accessor ies B Less: capit al cont r ibut ions (max £ 5,000) (C) Revised list pr ice (capped at £ 80,000) D
We start with the list price of the car when new and t o t his we add on the s.121
cost of any accessories pr ovided wit h t he car . For example if you buy a new s.125 car , t he gar age will char ge you ext r a if you want leat her seat s or a CD player et c, so we need t o add t hese it ems on.
The next st ep is t o deduct any capital contributions made t o t he employer by t he employee. A capit al cont r ibut ion is a one-of f payment made by t he employee s.132 t o enable t he employer t o pr ovide a bet t er car .
List pr ice, plus accessor ies, minus capit al cont r ibut ions gives a r evised list pr ice which in the proforma we have called “D”. This list price cannot exceed s.121 £80,000 f or t ax pur poses.
I f an accessor y is added t o t he car af t er it was f ir st made available t o t he employee, we only need t o add on t he cost t o t he list price if t he accessory cost s.126 mor e t han £ 100. I f not , we can ignor e it .
With regard to capital contributions, t he maximum deduction f rom the list pr ice is £5,000. I f an employee makes a capit al cont r ibut ion of £ 1,000, t his s.132(3) amount is deduct ed f rom t he list price. However if an employee makes a capit al cont ribution of £ 6,000, the list price is reduced by £ 5,000 only.
D3.3 Cash Equivalent
The basic cash equivalent is t he list price, mult iplied by a cer t ain per cent age. s.139(2) & This per cent age will depend on t he amount of CO emit t ed by t he car. The 2 (3) minimum char ge is 15%, r ising t o a maximum char ge of 35%.
We can see t wo t hings her e. Fir st ly t he benef it depends on t he type of car we have – t he mor e expensive t he car , t he higher t he benef it . Secondly, employees
who dr ive ar ound in lar ge car s wit h high CO2 emissions will pay mor e t ax t han t hose who ar e mor e envir onment ally f r iendly and have use of car s wit h low emissions.
The list price, mult iplied by t he appr opr iat e per cent age gives us t he basic cash equivalent.
310 Principles of Business Taxat ion ‘Finance Act 2006’
The benef it is r educed if the car has not been available t o t he employee for s.143(1) the whole of the tax year. For example, t he employee may have been given use
of t he car par t way t hr ough t he year or he may have ret urned t he car t o t he employer bef or e t he end of t he year . We do a pro-rata apportionment by r emoving t he number of mont hs dur ing which t he car was not available t o t he employee.
For example, if a t axpayer j oined a company on, say, 1 J anuar y 2007 and was given use of a car on t hat dat e, t hat per son will have had t he car f or only 3 mont hs of 2006/ 07. We t her ef or e r emove nine t welf t hs of t he car benef it .
As is t he case f or t he vast maj or it y of benef it s, if t he employee is r equir ed t o make a cont r ibut ion t owar ds t he benef it and act ually does so, t hese cont r ibut ions r educe t he cash equivalent . This is quit e common in pr act ice as s.144 wit h many car schemes, employees make mont hly cont r ibut ions t o t heir employer f or t he use of t he car . These r educe t he t axable benef it .
Her e is t he r est of t he pr of or ma t o f ind t he car benef it f or t he t ax year. The f inal cash equivalent will be ent er ed by t he employer on t o t he employee’s P11D:
£ Revised list pr ice D
Basic cash equivalent E D x %
- depends on CO2 emissions - minimum 15%, maximum 35%
Less: non availabilit y (n/ 12) (F) G Less: employee cont r ibut ions (H)
Car Benef it I
D3.4 Determining the percentage s. 133
The next st ep is t o det er mine t he r elevant per cent age. List pr ice is mult iplied
by a per cent age which depends ent ir ely on t he car ’s r ecor ded CO2 emissions. The higher t he emissions, t he higher t he per cent age.
Car bon dioxide emissions ar e measur ed in t er ms of t he grams per kilometre (g/km) of gas emit t ed f r om t he car .
For 2006/ 07 t here is a “baseline” figure of 140 g/km. This means t hat all car s
emit t ing CO2 at a r at e of 140 g/km or less will be t axed at t he minimum rate of 15%. The baseline will be t he same f or 2007/08 but is t o reduce t o 135 g/ km in 2008/ 09.
Company Car & Fuel Benef it s 311
The r elevant per cent age will increase by 1 for each additional 5 g/km of CO2
emitted above 140 f or 2006/ 07. For example, a car wit h r ecor ded CO2 emissions of 145 gr ams per kilomet r e, will be t axed using a per cent age of 16%, s.139(3) and so on.
The f or mula f or calculat ing t he per cent age is:
% = [(Emissions – 140) 5] + 15%
We t ake t he CO2 emissions of t he car and deduct t he baseline f igur e of 140. We divide t he r esult by 5 and add it t o t he minimum of 15% t o give t he r elevant per cent age. This is t hen mult iplied by t he list price of t he car t o give t he basic cash equivalent .
Illustration 1
An employee has use of a company car wit h a list pr ice of £ 20,000. Accessor ies ar e added t o t he car at a cost of £ 2,000. The employee made a one-of f capit al
cont ribut ion of £ 4,000 f or t he use of t he car. The car has r ecor ded CO2 emissions of 195 g/ km. £ List pr ice 20,000 Add: Accessor ies 2,000 Less: Capit al cont r ibut ion (4,000) Revised list pr ice £ 18,000
Cash equivalent £ £ 18,000 x 26% [(195-140) ÷ 5 = 11 + 15] 4,680
D3.5 Further points
I n r ealit y, CO2 emissions f igur es ar e exact numbers and ar e not r ounded t o t he near est whole mult iple of 5. For t ax pur poses, we ar e allowed t o round down to s.139(5) the nearest 5 g/km.
For example, if a car has a CO2 emissions f igur e of 199 g/ km, we would r ound t his down t o 195 t o det er mine t he per cent age.
The per cent age can never exceed 35%. This r at e will t her ef or e apply f or all car s wit h an emissions f igur e of 240 g/ km or above.
Ther e is a 3% supplement f or car s which r un on diesel – i.e. an addit ional 3% is added t o t he r elevant per cent age. This is because diesel engines ar e less s.141 envir onment ally f r iendly t han petrol engines. The minimum percentage which can t her ef or e be applied t o a diesel vehicle is 18%. The 3% supplement cannot t ake t he r elevant per cent age above 35%.
312 Principles of Business Taxat ion ‘Finance Act 2006’
Electric car s pr oduce no CO2 emissions and r eceive a 6% discount. The SI 2001/ 1123 per cent age t o be applied in t hese cases will t her ef or e be 9%. Ther e ar e also
discount s f or car s r unning on r oad f uel gas (e.g. liquid pet r oleum gas or LPG). s.146
From 2008/ 09, a f ixed rat e of 10% will apply f or cars wit h CO2 emissions of 120 g/ km or less.
D3.6 No emissions figure s. 140, s.142
Cer t ain vehicles, par t icular ly old ones, will have no r ecognised or r ecor ded CO2 emissions f igur e. I n t hese cases, t he per cent age we use t o calculat e t he benef it will be based on the engine size of t he vehicle. The engine size is measur ed in t er ms of t he vehicle cylinder capacit y in cubic cent imet res.
The per cent ages f or car s r egist er ed before 1 January 1998 ar e shown in t he t able below and r ise f r om a minimum of 15% f or small car s t o 32% f or lar ger vehicles.
The per cent ages ar e slight ly dif f er ent f or car s r egist er ed on or after 1 January 1998. Again t he minimum is 15%, t his t ime r ising t o t he usual upper limit of 35%.
Once again, a 3% supplement is added f or diesel car s, again capped at a maximum of 35%. Engine Size Pre 1.1.98 Post 1.1.98 0 - 1,400 cc 15% 15% 1,401 – 2,000 cc 22% 25% over 2,000 cc 32% 35%
D3.7 Non-availability s.143
The benef it is r educed if t he employee does not have use of t he car t hr oughout t he whole of t he t ax year . This will apply if an employee joins a company par t way t hr ough t he year and is given use of a car , or if an employee leaves t he company and has t o r et ur n t he car .
Appor t ionment is done on a mont hly basis by r emoving t he benef it arising in t he per iod in which t he employee did not have use of t he car .
I f a car is being r epair ed or ser viced, or having it s MOT, a non-availabilit y s.143(2) deduct ion can only be made if t he car is of f t he road f or a cont inuous per iod of at least 30 days.
So, if t he car is in t he gar age f or one week having a f ew minor r epair s, t his will have no ef f ect what soever on t he car benef it calculat ion. However if t he car is involved in a ser ious accident and is of f t he r oad f or , say, 2 mont hs, we would t ake a non-availabilit y deduction of 2 out of 12 mont hs.
Company Car & Fuel Benef it s 313
Illustration 2
An employee has use of a company car wit h a list price of £ 12,000. The car has
a CO2 emissions level of 152 g/ km. The employee is given use of t he car f or t he f ir st t ime on 1 J uly 2006. The employee makes cont r ibut ions of £ 40 per mont h t o t he employer f or t he use of t he car.
Dur ing t he year , t he car was of f t he r oad f or 3 weeks having some minor r epair s af t er an accident .
To calculat e t he benef it f or 2006/ 07 t he st ar t ing point is t he list pr ice of
£ 12,000. We mult iply t his by a per cent age based on t he car ’s CO2 emissions, which we know to be 152 g/km. As this is not exactly divisible by 5, we round down and use an emissions f igur e of 150 in t he f or mula.
As t he car was only available t o t he employee f r om 1 J uly 2006 – i.e. f or 9 months of the tax year – we must take a non-availabilit y deduct ion f or 3/ 12t hs of t he benef it . Not e t hat no r educt ion has been made f or t he 3 weeks dur ing which t he car was being r epair ed as t his per iod is less t han 30 days.
The employee is r equir ed t o make a cont r ibut ion of £ 40 per mont h f or t he use of t he car . As is t he case f or t he maj or it y of benef it s, employee cont r ibut ions act t o r educe t he cash equivalent .
£ List pr ice 12,000
Cash equivalent 12,000 x 17% [(150 – 140) ÷ 5 = 2 + 15] 2,040 Less: non-availabilit y 3 x 2,040 12 (510) Less: cont r ibut ions 40 x 9 (360) Benef it £ 1,170
D3.8 More than one car
An employee may have use of t wo company car s or he may have one car himself and a second car f or a member of his f amily or household.
I n t his inst ance, t he employee simply has two benefits, each calculat ed in t he
same way – i.e. using list pr ice and CO2 emissions. Note that if a car is made available by an employer f or a member of t he employee’s f amily, it is t he employee who will have the benefit, not the family member.
314 Principles of Business Taxat ion ‘Finance Act 2006’
D3.9 Classic cars s.147
A "classic car ” is one t hat is mor e t han 15 year s old and whose mar ket value at t he end of t he t ax year is mor e t han £ 15,000.
I f an employee is pr ovided wit h a classic car , t o wor k out t he cash equivalent we use the market value of the car when it was given t o t he employee inst ead of t he list pr ice when new.
D3.10 Pool cars and emergency vehicles s.167
No benef it will ar ise if t he employee has some incident al pr ivat e use of a pool car . A pool car is essent ially a shar ed vehicle which is mainly used f or business pur poses.
As long as pr ivat e use is incidental and t he pool car is not normally kept overnight at the employee’s residence, no benef it will ar ise. Many employer s have a small fleet of pool cars which ar e nor mally kept somewher e on t he pr emises and which ar e used f or business j our neys.
Ther e is also no t axable benef it when emer gency ser vice vehicles used by f ir e, s.248A police or ambulance wor ker s ar e t aken home when on-call.
D3.11 Administration
Employer s have t o f ile quar t er ly r et ur ns t o t he Tax Of f ice on f orm P46 (car) giving det ails of any changes in car s pr ovided t o employees.
D3.12 Fuel benefits
A separate benefit will ar ise wher e private petrol costs ar e r eimbur sed. I f s. 149, t he employer only pays f or f uel f or business pur poses, no benef it will ar ise. s.151(3)
If an employee is pr ovided wit h f uel f or pr ivat e mot or ing, t he t axable benef it is ident if ied by using t he f or mula below:
£ 14,400 x % based on CO2 emissions s. 150
To calculat e t he appr opr iat e per cent age, we use exact ly t he same r ules as above f or car benef it pur poses.
No f uel benef it will ar ise if an employee is r equir ed t o r eimbur se t he whole of s. 151(2) t he expense incur r ed by t he employer in pr oviding pr ivat e f uel and act ually does so. I f t he employee only makes a par t ial r eimbur sement , t his will have no ef f ect
and t he benef it will be calculat ed as above. Ther ef or e an employee cont r ibut ion t owar ds t he cost s of pr ivat e f uel will not r esult in a “pound-f or -pound” r educt ion in t he t axable amount as is t he case f or ot her benef it s.
Company Car & Fuel Benef it s 315
The f uel benef it will be reduced if privat e use f uel is not pr ovided t o t he s. 152 employee f or t he whole of t he t ax year . However , if pr ivat e f uel is wit hdr awn but t hen r einst at ed in t he same t ax year , t he benef it char ge will apply f or t he whole t ax year . So it is not possible t o opt in and out of t he car f uel benef it , f or
example dur ing holidays.
Illustration 3
Ralf is pr ovided wit h a car by his employer on 1 Oct ober 2006. The car has a list
pr ice of £ 15,000 and CO2 emissions of 168g/ km. All f uel cost s ar e met by t he company. The cost s of pr ivat e f uel amount ed t o £ 2,000 of which Ralf r eimbur sed £ 750.
The t axable benef it s in 2005/ 06 are: £ Car : £ 15,000 x 20% [(165 – 140) ÷ 5 = 5% + 15% = 20%] 3,000 Less: non-availabilit y £ 3,000 x 6/ 12 (1,500) Car benef it 1,500 Fuel benef it £ 14,400 x 20% x 6/ 12 1,440 Total £ 2,940
No r educt ion f or par t ial r eimbur sement of pr ivat e f uel. Not e a r educt ion would have been made if Ralf had cont r ibut ed £ 750 t owar ds t he gener al r unning cost s of the car itself (rather than the f uel directly), provided that this was a condit ion st ipulat ed by t he employer .
Example 1
Eddie is pr ovided wit h use of a J aguar car f or t he whole of 2006/ 07. The list price is
£ 32,000 and CO2 emissions ar e 233 g/ km.
Eddie pays £ 50 per mont h f or t he use of t he car . All his pet r ol cost s ar e met by t he company.
Calculat e Eddie’s t axable benef it f or 2006/ 07.
Example 2
J ensen has use of a Volvo car (list pr ice £ 12,000 and CO2 emissions 148g/ km). On 1 J uly
2006 his employer exchanged t he Volvo f or an Audi (list price £ 14,000 and CO2 emissions 139 g/ km). The Audi r uns on diesel. The company r eimbur se J ensen f or business f uel cost s only.
Calculat e J ensen’s t axable benef it f or 2006/ 07.
316 Principles of Business Taxat ion ‘Finance Act 2006’
Answer 1
List pr ice £ 32,000
Cash equivalent £ £ 32,000 x 33% [(230-140) ÷ 5 = 18 + 15] 10,560 Less: employee cont r ibut ions (12 x £ 50) (600) Car Benef it 9,960 Add: Fuel benefit - £14,400 x 33% 4,752 Taxable Benef it s £14,712
Answer 2
Volvo (3 mont hs) List price £12,000 Cash equivalent £ £ £ 12,000 x 16% [(145-140) ÷ 5 = 1 + 15] 1,920 Less: non availabilit y 9 £ 1,920 x 12 (1,440) 480 Audi (9 mont hs) List price £ 14,000 Cash equivalent £14,000 x 18% [15% + 3%] 2,520 (<140g/ km plus diesel supplement ) Less: non availabilit y 3 £ 2,520 x 12 (630) 1,890 Tot al benef it £2,370
Company Car & Fuel Benef it s 317
SUMMARY - COMPANY CAR & FUEL BENEFITS
Company car benef it is not char geable on lower paid employees who ar e not dir ect or s
Company car benef it is based on a number of f act or s including list pr ice and CO2 emissions.
List pr ice includes accessor ies and is r educed by capit al cont r ibut ions of up t o £ 5,000. Ther e is an over all cap of £ 80,000.
A per cent age is applied t o t he list pr ice. The per cent age will be bet ween 15% and 35%.
The “baseline” f igur e f or CO2 emissions f or 2006/ 07 is 140g/ km.
The r elevant per cent age is calculat ed as
% = [emissions – 140] ÷ 5 + 15%
The emissions f igur e is r ounded down t o t he near est 5g/ km.
Ther e is a 3% supplement f or car s which r un on diesel.
As elect r ic car s pr oduce no emissions a per cent age of 9% only is used.
Older car s wit h no r ecor ded emissions f igur e use per cent ages based on engine size which var y accor ding t o whet her t he car was r egist er ed bef or e or af t er 1 J anuar y 1998.
I f t he employee has had t he car f or less t han a year , t he benef it is t ime appor t ioned.
Non-availabilit y deduct ions only apply if t he car is of f t he road f or 30 days.
Classic car s ar e t hose over 15 year s old and wor t h mor e t han £ 15,000 at t he end of t he t ax year . Mar ket value is used inst ead of list pr ice.
Wher e f uel is pr ovided f or pr ivat e mot or ing, t he t axable benef it is:
£ 14,400 x % (based on CO2 emissions)
Fuel benef it s cannot be r educed by employee cont r ibut ions but can be t ime appor t ioned if appr opr iat e.
D4: LIVING ACCOMMODATION – TAXABLE BENEFITS
I n t his chapt er you will cover t he way in which t axable benef it s f or living accommodat ion pr ovided by t he employer ar e calculat ed including: - j ob r elat ed accommodat ion; - r ent ed accommodat ion; - employer owned accommodat ion; - accommodat ion cost ing > £ 75,000; - t he 6 year rule; - household expenses.
St at ut or y r ef er ences ar e t o I TEPA 2003 unless st at ed ot her wise.
D4.1 Introduction
I f a house, f lat or any propert y t hat is owned or rent ed by t he employer is made available f or use by an employee, t her e will be a t axable benef it f or t he employee as he is occupying a pr oper t y pr ovided t o him by his employer .
The pr ovision of living accommodation is a taxable benefit for all employees even lower paid employees.
The way t hat t he benef it is t axed depends on whet her t he accommodat ion is “j ob r elat ed” or “non j ob r elat ed”.
D4.2 “Job related” accommodation s.99
I f an employer pr ovides an employee wit h j ob r elat ed accommodat ion, t her e is no benef it ar ising t o t he employee on t he use of t hat accommodat ion.
Job related accommodation is accommodat ion which is “necessary” f or the job or is pr ovided f or t he “bet t er per f or mance” of t he employee’s dut ies. Employees such as publicans or caretakers will live in j ob r elat ed accommodat ion. Typically t hese ar e employees who ar e nor mally r equir ed by t heir employer s t o live on sit e in order t o do t heir job.
J ob r elat ed accommodat ion also cover s sit uat ions wher e accommodat ion is pr ovided “customarily” f or t he bet t er per f or mance of t he j ob. So f or example it is cust omar y t o pr ovide a vicar wit h a vicar age in t he par ish. This would const it ut e j ob r elat ed accommodat ion.
A dir ect or of a company cannot have his living accommodat ion classif ied as “j ob r elat ed” under s.99 unless eit her :
a) he does not have a “mat er ial int er est ” in t he company (>5% of t he shar es); and eit her b) he is employed as a f ull time working dir ect or or t he company is non-pr of it making or is est ablished f or char it able pur poses.
Living Accommodat ion – Taxable Benef it s 319
Finally, if accommodat ion is pr ovided by t he employer because t her e is a t hr eat s.100
t o t he employee’s physical “security”, t his will also const it ut e j ob r elat ed
accommodat ion. Cer t ain polit icians such as t he Chancellor or t he Prime Minist er live in j ob r elat ed accommodat ion on Downing St r eet and do not pay t ax on t he pr ovision by t he gover nment of t heir living accommodat ion.
D4.3 Rented accommodation
For t he r est of t his chapt er we ar e going t o look at how we calculat e t he benef it s wher e t he accommodat ion pr ovided t o t he employee is not j ob r elat ed. We will st ar t by looking at how we calculat e t he cash equivalent wher e t he property is rented by the employer.
The benef it - i.e. t he cash equivalent - is the higher of the rents paid by the s.105(4) employer f or t he use of t he pr oper t y, and the annual value of the property.
The “annual value” of living accommodat ion is def ined as t he rent which might s.110 reasonably be expected to be obtained on letting the property if t he t enant paid all t he usual household bills and t he landlor d met all r epair and maint enance cost s. The “annual value” will be pr ovided f or you in t he examinat ion.
I n pr act ice, however , t he Revenue will use t he gross rateable value of t he pr oper t y under t he old r at ing syst em as t he annual value. This will be much lower t han t he annual value as def ined in t he Act . I f t he pr oper t y has no r at eable value (f or example because it was built r ecent ly), an est imat e must be made. Any disput es as t o t he amount of t he annual value will be r ef er r ed t o t he Gener al Commissioner s f or r uling.
We t hen deduct any employee contributions – i.e. any r ent s paid by t he employee t o t he employer f or t he use of t he pr oper t y. This will give us t he cash equivalent .
Higher of : Rent s paid by employer X
Annual value of pr oper t y
Less: employee contr ibutions (X) Taxable benefit X
Remember t hat t his met hod of calculating t he benef it only applies wher e t he employer is renting t he accommodat ion f r om anot her landlor d.
D4.4 Employer owned accommodation
Ther e ar e similar r ules wher e t he employer owns t he accommodat ion being made available t o t he employee.
320 Principles of Business Taxat ion ‘Finance Act 2006’
Once again, t he st ar t ing point in calculating t he benef it is t he annual value. I f s. 105(2) t he accommodat ion cost t he employer less t han £ 75,000, t hen t he benef it is equal t o t he annual value.
I f t he house cost t he employer more than £75,000, t her e will be an addit ional s. 106 benef it t o t he employee called t he addit ional year ly r ent – t his extra benefit will be added to the annual value t o give t he t ot al benef it.
To calculat e t he addit ional year ly r ent we st ar t by t aking t he cost of t he accommodat ion - her e “cost ” means t he original cost plus any impr ovement s. Fr om t his we deduct £75,000, and multiply t he dif f erence by t he “ORI” which is t he Revenue’s of f icial int er est r at e at t he start of the tax year.
When calculat ing t he “cost ” of t he proper t y, only impr ovement s car r ied out s. 104 bef or e t he beginning of t he t ax year ar e t aken int o account . I mpr ovement s
under t aken dur ing t he year will af f ect t he “cost ” used in calculat ing t he benef it f or t he f ollowing year .
I f t he employee makes a cont r ibut ion t owar ds t he benef it , t his can be deduct ed in ar r iving at t he t axable cash equivalent .
I f employee cont r ibut ions exceed t he amount of t he benef it , no loss will ar ise. The r esult is simply a benef it of zer o.
Annual Value X Add: Addit ional yearly rent if Cost > £ 75,000 £(Cost – £75,000) x ORI at start of year X X Less: employee contr ibutions (X) Taxable Benefit X
Illustration 1
An employee lives in accommodat ion t hat is owned by his employer . The house cost t he employer £ 100,000 and has an annual value of £ 1,000. The employee pays rent t o t he employer of £ 100 per mont h f or t he use of t he house. Assume t he Revenue’s of f icial r at e of int er est is 5%.
The calculat ion t he t axable benef it t hat will be ent er ed ont o t he employee’s f or m P11D will be as f ollows: £ Annual Value 1,000 Addit ional yearly rent : (100,000 – 75,000) x 5% 1,250 2,250 Less: employee cont r ibut ions: (£ 100 x 12) (1,200) Taxable Benef it £1,050
Living Accommodat ion – Taxable Benef it s 321
D4.5 The “6 year” rule s. 107
The “6 year r ule” applies when a house was bought by an employer and is made available f or use by t he employee mor e t han 6 years af t er it had been f irst acquir ed. The addit ional year ly r ent al in r espect of accommodat ion will not be based on cost . I nst ead, t he char ge will be based on t he mar ket value of t he house on t he dat e t he pr oper t y was made available t o t he employee.
I n ef f ect we ar e subst it ut ing mar ket value in place of or iginal cost . Not e t hat t his r ule only applies wher e t her e ar e mor e t han 6 year s bet ween t he pr oper t y being acquir ed by t he employer and it being made available t o t he employee.
Illustration 2
An employee was pr ovided wit h a house by his employer in J une 1998. He pays £ 100 a mont h f or use of t he house. The house had been pur chased £ 100,000 in 1990 and has an annual value of £ 1,000. The house had a mar ket value of £ 120,000 in J une 1998. Assume an of f icial r at e of int er est of 5%.
The benef it will be calculat ed as f ollows: £ Annual Value 1,000 Additional yearly rent £(120,000 – 75,000) @ 5% 2,250 Less: employee cont r ibut ions (1,200) Taxable Benef it £2,050
As house pr ices nor mally r ise over t ime, we would expect t he original cost t o be less t han a lat er mar ket value. However , if property prices fall such that when t he employee moves in mor e t han 6 year s lat er , t he mar ket value is less t han or iginal cost , this market value of the property will still be used to calculate the benefit even t hough it is less t han or iginal cost .
I f t he or iginal cost of t he accommodat ion is less than £75,000, t here will not s. 107(1)(b)
be additional yearly rent, r egar dless of cur r ent mar ket value. For example, if a
company buys a house in London in t he 1960s f or , let ’s say, £ 20,000, and t he employee is given use of t he pr oper t y t oday when t he house is wor t h, say, one million pounds, t her e is no addit ional char ge because t he or iginal cost is below
t he £ 75,000 t hreshold.
I f the house is not made available t o t he employee for the whole of the tax year - i.e. t he employee moves in or moves out dur ing t he year - t he benef it needs t o be appor t ioned. Appor t ionment can be done on a mont hly basis.
I f t he same living accommodat ion is pr ovided f or mor e t han one employee at t he s. 108 same t ime, t he cash equivalent of t he benef it (as calculat ed above) is appor t ioned bet ween t he employees on a “j ust and r easonable” basis.
322 Principles of Business Taxat ion ‘Finance Act 2006’
D4.6 Household expenses
I f the employer pays any household bills on behalf of t he employee, f or example gas, electricity and telephone bills etc, this will give rise to an additional and separate benefit. This benef it is calculat ed by t aking t he cost t o t he employer of paying t hese par t icular bills.
Ther e is a special r ule r elat ing t o expenses paid on behalf of employees who live in job related accommodation.
Illustration 3
Assume a vicar is living in j ob r elat ed accommodat ion. The vicar will not have a benef it on t he pr ovision of t he house, as t he accommodat ion is j ob r elat ed.
The vicar has a salar y of £ 20,000 and his employer pays f or t he gas, elect r icit y and t elephone bills r elat ing t o t he house. These come t o £ 2,300. As t he employer dischar ges t hese bills, t his gives r ise t o an addit ional benef it .
The special r ule says t hat wher e such expenses ar e paid on behalf of employees in j ob r elat ed accommodat ion, t he amount on which t he employee will be t axed in s. 315(3) r espect of t his benefit cannot exceed 10% of his other earnings from that & (4) employment for the year.
Her e t he vicar ’s ear nings f or t he year is his salar y of £ 20,000, so t he amount on which t he vicar will be t axed in r espect of t hese r eimbur sed expenses cannot exceed 10% of t his - ie £ 2,000.
This 10% r est r ict ion r ule only applies t o expenses pr ovided f or employees in j ob r elat ed accommodat ion. Where the accommodation is not job related, the full amount of the expenses are taxable.
Example 1
Neil lives in a company owned f lat . The f lat cost t he company £ 150,000 in 2002. The annual value is £ 800 and Neil pays rent of £ 150 per month. Neil moved out of t he f lat on 1 J anuar y 2007 and bought his own house.
Calculat e Neil’s t axable benef it assuming t hat t he of f icial int er est r at e is 5%.
Example 2
Alf is t he manager of t he Golden Lion Public House. He is employed on a salar y of £ 18,000 and is r equir ed t o live in t he f lat above t he pub. His benef it s f or t he year ar e as f ollows: £ Privat e medical insur ance 500 Gas and electricity bills for flat 2,200
Calculat e Alf ’s t axable employment income f or t he year .
Living Accommodat ion – Taxable Benef it s 323
Answer 1
£ Annual value 800 Addit ional charge: £ (150,000 – 75,000) @ 5% 3,750 4,550
9 3,412 x (6.4.05 - 1.1.06) 12 Less: employee cont r ibut ions (£ 150 x 9) (1,350) Taxable Benef it £2,062
Answer 2
£ Salary 18,000 Medical I nsur ance (amount t r eat ed as ear nings) 500 18,500 Living expenses £ 2,200 Rest r ict ed t o 10% x £ 18,500 1,850 Tot al employment income £20,350
Accommodat ion is j ob r elat ed so t he r est r ict ion in s.315 applies.
324 Principles of Business Taxat ion ‘Finance Act 2006’
SUMMARY - LIVING ACCOMMODATION
J ob r elat ed accommodat ion is a t ax f r ee benef it . This is wher e t he accommodat ion is: a) necessar y f or t he j ob; or b) cust omar y or pr ovided f or t he bet t er per f or mance of t he job; or c) pr ovided because of a t hr eat t o t he employee’s secur it y
Non-j ob r elat ed accommodat ion is a t axable benef it f or all employees.
The benef it f or r ent ed accommodat ion is t he higher of r ent s paid by t he employer and t he annual value.
I f t he employer owns t he pr oper t y, t he benef it is t he annual value.
Addit ional year ly r ent is calculat ed if t he propert y cost > £ 75,000 as: (Cost - £ 75,000) x ORI at st art of year
ORI is t he of f icial r at e of int er est .
I f t her e was mor e t han 6 year s bet ween t he pur chase of t he pr oper t y and t he employee moving in, t he mar ket value of t he pr oper t y at t he dat e t he employee moved in is subst it ut ed f or cost in t he above f or mula.
Any household expenses paid by t he employer also lead t o a benef it f or t he employee. I f t he employee is in j ob r elat ed accommodat ion, t he benef it is limit ed t o 10% of t he ot her ear nings f r om t his employment f or t he year .
D5: LOANS TO EMPLOYEES & USE OF ASSETS
I n t his chapt er you will cover t axat ion of t he f ollowing benef it s: - t he pr ovision of a t axable cheap loan; - use of a company owned asset ; - t r ansf er of an asset f r om employer t o employee.
St at ut or y r ef er ences in t his chapt er ar e t o I TEPA 2003 unless st at ed ot her wise.
D5.1 Loans to employees s.173 – s.191
When a company lends money t o an employee, t his is likely t o give rise t o a t axable s.175 benef it called a t axable cheap loan. The cash equivalent of t he benef it is calculated using the Revenue’s of f icial rate of interest. I f no interest is charged or t he int er est r at e is less t han t he of f icial r at e of int er est , t he cash equivalent is t he dif f er ence bet ween t he int er est t hat would have been payable at t he of f icial r at e of int er est and any int er est which is paid.
Ther e ar e t wo ways in which we can calculat e t he cash equivalent . The f ir st is by s.182 s.183 using t he average method, and t he second uses t he strict method. The aver age met hod is per haps mor e commonly used alt hough eit her t he t axpayer or t he Revenue can insist t hat t he st r ict met hod is used inst ead.
The employee will have no t axable benef it if t he aggr egat e of all loans out st anding s.180 t hr oughout t he t ax year is £ 5,000 or less. Ther ef or e if t he employee makes one
loan t o t he employee and t hr oughout t he t ax year t his loan never exceeds £5,000, the taxable benefit is zero.
This pr ovision is int ended t o exempt such t hings as season t icket loans, so f or t hose of you who t r avel t o wor k on public t r anspor t and have an annual t r avel car d obt ained via a loan f r om your employer , as long as t he t r avel car d cost s £5,000 or less (and you don’t have any mor e loans), you will not have a t axable benef it .
Not e here t hat t he £5,000 rule refers to the aggregate of all loans in t he year s.180(2) – t his is t o pr event an employer abusing t he r ules by of f er ing a ser ies of loans t o t he same employee, each of j ust under £ 5,000.
D5.2 Average Method s.182
Under t he aver age met hod we st ar t by t aking t he loan out st anding at t he start of t he t ax year – i.e. at 6 Apr il – and t o t his we will add on t he loan out st anding as at the end of t he t ax year – i.e. at t he f ollowing 5 Apr il. Having added t hese t oget her , we divide by t wo t o give t he average loan outstanding dur ing t he year.
326 Principles of Business Taxat ion ‘Finance Act 2006’
I f t her e is no loan out st anding at t he st ar t of t he t ax year – f or example t he employer makes t he loan t o t he employee par t way t hr ough t he year – we st ar t by using t he amount of t he loan at the point it was made. Similarly if t he loan out st anding at t he end of t he year is nil – f or example if t he loan is complet ely repaid during the year – we add on the amount of the loan at the point it was repaid.
Having ar r ived at t he aver age loan f or t he year , we mult iply t his by t he Revenue’s aver age of f icial r at e of int er est (ORI ) f or t he year.
Loan at 6 Apr il + Loan at 5 Apr il x aver age ORI f or t ax year 2 If the employee is required to make some sort of contribution – i.e. if the employee pays some int er est t o t he employer on t he loan – t hese contributions reduce the cash equivalent.
D5.3 Strict method s.183
Under t he st r ict met hod we simply calculate interest on a daily or monthly basis on t he exact amount s of t he loan out st anding dur ing t he t ax year .
Eit her t he t axpayer or t he Revenue has t he right t o insist t hat t he st rict basis be s.183(1) used inst ead of t he aver age basis.
I f t he st r ict basis gives a lower cash equivalent t han t he aver age basis, t he t axpayer would be advised t o elect f or t his st r ict basis t o apply. Alt ernat ively, if t he st r ict basis gives r ise t o a higher benef it , you would expect t he Revenue t o insist t hat we use t his st r ict basis.
However t he Revenue will only insist on t he st r ict basis if t he aver age basis gives a significantly distorted result – if t her e is only a f ew pounds dif f er ence bet ween t he t wo, t he Revenue will not insist on t he st r ict basis.
Illustration 1
Paul bor r ows £ 100,000 f r om his employer in 1999 and uses t he money t o buy a house. The loan is int er est f r ee so Paul is not r equir ed t o make any employee cont r ibut ions. Paul r epays £ 20,000 of t he loan on 1 December 2006.
I n order t o f ind t he cash equivalent we must calculat e t he benef it using bot h t he aver age and t he st r ict basis t hen compar e t he result s. We will assume an of f icial r at e of 5%.
Loans t o Employees & Use of Asset s 327
Aver age basis: 100,000 + 80,000 = 90,000 x 5% £ 4,500 2
St rict basis: 8 100,000 x x 5% 12 3,333 4 80,000 x x 5% 12 1,333 £4,666
Either the Revenue or the taxpayer can insist on the use of the strict basis. I t makes no sense f or Paul t o make an elect ion her e as t he st r ict basis gives a higher benef it . The Revenue will only insist on using t he st r ict basis – i.e. on t axing t he £ 4,666 – if t hey f eel t hat t he aver age basis had signif icant ly dist ort ed t he benef it .
Her e, t he Revenue would not bot her so t he aver age basis would be used. The t axable cash equivalent would t her ef or e be £ 4,500.
I f t he loan r emains r easonably const ant t hr oughout t he year , when pr epar ing t he P11D t he aver age basis is usually used.
However if t he loan out st anding is changing – i.e. amount s ar e being r epaid or addit ional loans ar e being t aken out – it will be mor e usual t o pr epar e t he P11D using t he st r ict basis.
s.205 D5.4 Use of employer’s assets
I f an employer lends an asset t o one of his employees, t his will give r ise t o a taxable benefit. Not e t hat t he employer is allowing t he employee t o use t he asset – owner ship of t he asset r emains wit h t he employer and does not t r ansf er t o t he employee.
The benef it in t his inst ance is t he higher of :
a) t he annual value of t he use of t he asset ; or b) t he sums paid by t he employer in pr oviding t he asset by way of r ent or hir e char ge.
The “annual value” r ef er r ed t o above is 20% of the market value of t he asset at t he t ime it was f ir st made available t o t he employee.
I f the employee makes a contribution – i.e. he pays some sort of rent to the employer f or t he use of t he asset – we can deduct t his t o arrive at t he t axable cash equivalent .
328 Principles of Business Taxat ion ‘Finance Act 2006’
I f t he asset is lent t o t he employee par t way t hr ough t he year , having calculat ed t he basic cash equivalent , we must t hen apportion t his f or t he number of mont hs in t he year in which t he employee had use of t he asset .
This r ule will of t en apply in r elat ion t o f ur nit ur e pr ovided by t he employer in living accommodat ion made available t o t he employee.
Because t he asset r emains t he pr oper t y of t he employer , at some point t he employee will be r equir ed t o give it back. I f t he employee doesn’t r et ur n t he asset t o t he employer – i.e. t he employer allows t he employee t o keep t he asset - t her e will be a t axable benef it on t his t r ansf er .
D5.5 Transfer of assets
The benef it will be t he higher of : s.206
a) The mar ket value of t he asset at t he dat e it was t r ansf er r ed t o t he employee.
b) The mar ket value of t he asset at t he dat e it was or iginally lent t o t he employee r educed by any amount s which have been char ged t o t ax in r espect of t he employee’s use of t he asset .
S.206 I TEPA 2003 cont ains a “st ep-by-st ep” appr oach in how t o comput e t his benef it .
The Revenue will t ake whichever is t he higher and will t ax t his f igure. Any payment s made by t he employee t o t he employer f or t he t r ansf er of t he asset can be deduct ed.
Illustration 3
An employer lends a paint ing t o an employee on 1 J anuar y 2004. At t his dat e t he paint ing was wor t h £ 100,000.
On 30 Sept ember 2006, t he employer allows t he employee t o keep t he paint ing. I t is wort h £ 40,000 at this point.
Benef it f or use of paint ing: £ 3 2003/ 2004: £ 100,000 x 20% x 12 5,000 2004/2005: £100,000 x 20% 20,000 2005/2006: £100,000 x 20% 20,000 6 2006/ 2007: £ 100,000 x 20% x 12 10,000 55,000 Benef it on gif t is higher of : a) MV @ t ransf er 40,000 b) Original MV 100,000
Loans t o Employees & Use of Asset s 329
Less: already charged f or use (55,000) 45,000 i.e. 45,000
Benef it f or use in 2006/ 07 (f r om above) 10,000 Benef it on t r ansf er 45,000 Tot al Benef it in 2006/ 07 £ 55,000
D5.6 Transfers of cars or houses
The r ules above on t r ansf er s of asset s do not apply when asset s such as cars or houses ar e given t o employees.
Wher e an employee has use of a company car and at a lat er dat e t hat car is t r ansf er r ed t o t he employee, t he benef it is t he market value of the car at t he dat e of t he t r ansf er minus any payment s made by t he employee f or t he t r ansf er of t he car . The r ules r egar ding amount s pr eviously char ged t o t ax do not apply her e.
This ar r angement commonly applies as par t of a t er minat ion agr eement . I f an employee is made r edundant , t o sof t en t he blow t he employer may allow t he ex- employee t o keep his company car .
The same r ule applies t o t r ansf er s of houses.
s.320 D5.7 Use of computers – rules up to 2005/06
I f “comput er equipment ” is lent by an employer t o an employee and t he employee uses t hat equipment f or pr ivat e pur poses, t his will give r ise t o a t axable benef it . The benef it is calculat ed using t he “20% r ule” as descr ibed above.
“Comput er equipment ” includes pr int er s, scanner s, modems and ot her similar devices, as well as t he r ight t o use comput er sof t war e. I t does not , however , include “access t o, or t he use of , public elect r onic communicat ions” (f or example, line r ent al t o f acilit at e use of t he I nt er net ).
Blackber r ies have now been classif ied as comput er equipment (having pr eviously been r egar ded as mobile phones).
Up t o 5 April 2006, t he first £500 of t he benef it is exempt f rom t ax. The benefit in excess of £500 is taxable. Ther ef or e if an employer had a comput er wor t h £ 2,500 and t his was lent t o an employee t o use pr ivat ely, t he benef it was 20% of the £ 2,500 being £ 500. This benefit would then have been completely exempt f r om t ax. Char ges t her ef or e only ar ose wher e t he cost of equipment exceeded £ 2,500.
I t is common in pr act ice f or an employer t o allow an employee t o use a desk t op or a lap t op f or some pr ivat e pur poses. The “£ 500 r ule” meant t hat most employees wer e unlikely t o have a benef it in r espect of t heir incident al pr ivat e use.
330 Principles of Business Taxat ion ‘Finance Act 2006’
I f t he comput er is subsequent ly t r ansf er r ed t o t he employee, t he benef it is calculat ed by using t he mar ket value of t he comput er at t he dat e of t r ansf er . The or iginal acquisit ion cost calculat ion is not used in t his case.
D5.8 Use of computers – rules from 2006/07
The £ 500 exempt ion has been r emoved wit h ef f ect f r om 6 April 2006.
However , t he exempt ion cont inues t o be available f or employees who had been provided with computer equipment before 6 April 2006. I n ef f ect , t he exempt ion is only r emoved wher e comput er equipment is first made available t o t he employee on or af t er 6 Apr il 2006.
Employees who had use of a comput er bef or e Apr il 2006 but who lat er r eceived a r eplacement under war r ant y, will st ill be able t o claim t he £ 500 exempt ion. However if a new comput er is pr ovided out side t he war r ant y per iod, t he exempt ion is not available.
I f comput er equipment is pr ovided t o an employee solely for business use, t her e is no taxable benefit (hence t he £ 500 exempt ion is not r elevant in t his sit uat ion).
A mor e dif f icult issue ar ises when an employee uses t he comput er equipment par t ly f or business and par t ly f or non-business pur poses. I n t his inst ance, t he t ax t r eat ment depends on when t he comput er was f ir st made available t o t he employee.
To calculat e t he annual benef it , we apply t he f ollowing st eps;
I f available before 6 April 2006: calculat e t he benef it using t he 20% r ule; deduct £ 500; t hen deduct t he business pr opor t ion t o calculat e t he t axable benef it .
I f available after 5 April 2006: calculat e t he benef it using t he 20% rule; t hen deduct t he business pr opor t ion t o calculat e t he t axable benef it .
Illustration 4
Chancer y Lt d pr ovides J ames, an employee, wit h a deskt op comput er , wit h pr int er , scanner and int egr at ed sof t war e. The package cost t he company £ 8,000. J ames wor ks f r om home and uses t he equipment 70% of t he t ime f or business pur poses.
Loans t o Employees & Use of Asset s 331
(i) Assume equipment pr ovided on 31 Mar ch 2006.
The 2006/ 07 t axable benef it is as f ollows: £ Basic cash equivalent (£ 8,000 x 20%) 1,600 Less: exempt ion (500) Excess 1,100 Less: business use (70% x £ 1,100) (770) Taxable benef it f or pr ivat e use £ 330
(ii) Assume equipment pr ovided on 7 Apr il 2006.
The 2006/ 07 t axable benef it is as f ollows: £ Basic cash equivalent (£ 8,000 x 20%) 1,600 Less: exempt ion nil Excess 1,600 Less: business use (70% x £ 1,100) (1,120) Taxable benef it f or pr ivat e use £ 480
The r emoval of t he exempt ion has t her ef or e cr eat ed addit ional t echnical complicat ions as well as incr easing t he compliance bur dens on employer s who will have t o keep t r ack of when t he equipment is provided in order t hat t hey can correct ly calculat e t he benef it s f or t he pur poses of pr epar ing P11Ds.
However , some help is available by vir t ue of S.316(2) I TEPA 2003 which says t hat no liabilit y t o t ax will arise where t he employees pr ivat e use of an employer s asset s “is not signif icant ”. Ther e is no st at ut or y def init ion of what is “signif icant ”, but t his is accept ed by t he Revenue as applying t o cases wher e t he asset is pr imar ily pr ovided f or business pur poses but wher e pr ivat e use is incident al or t r ivial and “ver y much t he except ion in t er ms of t he pat t er n of use by t hat employee in t hat t ax year ”.
The Revenue (in t heir Employment Manual) will accept t hat no t axable benef it ar ises wher e:
• t he employer ’s policy concer ning privat e use of comput er s is clear ly st at ed t o employees, set t ing out cir cumst ances wher e occasional pr ivat e use can be made;
• and a decision of t he employer not t o r ecover t he cost s of employees’ pr ivat e use is a commer cial decision as t he administ r at ive cost s of so doing would exceeds t he amount s involved; and
• t her e ar e r easonable checks t o ensur e t hat t he employer ’s policy is being f ollowed in pr act ice.
332 Principles of Business Taxat ion ‘Finance Act 2006’
Even wit h t he par t ial r emoval of t he £ 500 exempt ion t her ef or e, employer s who have a st at ed policy per mit t ing incident al pr ivat e use of comput er equipment , should not need t o disclose t axable benef it s on employees’ P11Ds.
Example 1
Ron bor r owed £ 50,000 f r om his employer t o buy a house on 1 May 2006. The loan is int erest f ree. On 1 August 2006 Ron borrowed a f urt her £ 40,000 t o add an ext ension.
Calculat e Ron’s t axable benef it assuming an official interest rate of 5% t hr oughout .
Example 2
Lesley bor r ows a wide scr een TV and DVD player f r om her employer on 30 Sept ember 2005. The equipment was wor t h £ 800 at t hat dat e.
On 1 J uly 2006, Lesley bought t he equipment f r om her employer f or £ 200. I t was wor t h £ 450 at t hat dat e.
Calculat e Lesley’s t axable benef it f or 2006/ 07.
Loans t o Employees & Use of Asset s 333
Answer 1
Aver age met hod: 11 £ 3,208 50,000 + 90,000 = 70,000 x 5% x 12 2
Strict method: £ 3 625 50,000 x 5% x 12 8 3,000 90,000 x 5% x 12 £3,625
The Revenue may elect f or t he st r ict basis as t he aver age basis dist or t s t he benef it .
Answer 2
Benef it s f or use £ £ 2005/ 06: 6 80 800 x 20% x 12 2006/ 07: 3 800 x 20% x 12 40 120 Tr ansf er of equipment Higher of : a) MV at transfer 450
b) Original MV 800 Less: char ged alr eady f or use (120) 680
2006/ 07 £ Use of asset 40 Tr ansf er of asset 680 Less: paid by employee (200) Tot al t axable benef it £520
334 Principles of Business Taxat ion ‘Finance Act 2006’
SUMMARY - LOANS TO EMPLOYEES & USE OF ASSETS
I f a cheap loan is made t o an employee by his employer , it only leads t o a t axable benef it if t he aggr egat e of all loans out st anding t hr oughout t he t ax year exceeds £ 5,000.
Ther e ar e t wo met hods t o calculat e t he benef it . The aver age met hod is as f ollows:
Loan at 6 Apr il + Loan at 5 Apr il x aver age ORI f or t ax year 2
The st r ict met hod calculat es int er est on a mont hly basis using t he exact loan out st anding dur ing t he year .
The t axpayer can elect f or t he st rict basis if it is lower , t he Revenue will insist on t he st r ict basis if t he benef it would ot her wise be signif icant ly dist or t ed.
I f t he int erest is on a f ully qualif ying loan, t here is no t axable loan or deduct ion f or t he int er est . I f t her e is a pr ivat e or non qualif ying element , t he loan is a t axable loan, but r elief is given f or t he r elevant amount of qualif ying int er est .
I f an employee has t he use of an asset owned by his employer t he benef it is:
20% x MV of asset when f ir st pr ovided t o t he employee
I f t he employer allows t he employee t o keep an asset , t he benef it is t he higher of : a) MV when given; b) MV when or iginally pr ovided less amounts alr eady char ged f or use of t he asset .
These t r ansf er r ules do not apply t o car s nor houses given t o an employee, t he benef it her e is j ust MV less any amount paid by t he employee.
The f irst £ 500 of benef it calculated f or use of comput er equipment was t ax f r ee pr ior t o 2006/ 07. From 6 April 2006 t he exempt ion is r emoved f or comput er equipment pr ovided af t er t his dat e.
D6: MISCELLANEOUS BENEFITS
I n t his chapt er you will lear n about some miscellaneous benef it s including: - company vans; - voucher s; - mileage allowances; - t ax exempt benef it s.
St at ut or y r ef er ences in t his chapt er ar e t o I TEPA 2003 unless st at ed ot her wise.
D6.1 Company vans
Wher e an employer allows an employee exclusive use of a company owned van, t her e will be a t axable benef it . A “van” in t his cont ext is a mechanically pr opelled s.115(1) r oad vehicle which is a goods vehicle weighing less t han 3.5 t onnes. As a van is not a car , we do not use t he company car r ules t o calculat e t he benef it . The van r ules ar e ver y simple.
I f an employee has use of a new van, t he benef it is a f lat £500 per annum. If s.155
t he employee has use of an old van, t he benef it is £350. A van is new if it is less
than 4 years old at the end of the tax year.
These char ges ar e apportioned if t he van is not available f or t he whole of t he year . s.158 Wher e t he van is “shar ed” - i.e. concur r ent ly available t o mor e t han one employee – the cash equivalent is split between the employees based on the days it was available. The benef it char ge cover s t he pr ovision of f uel f or pr ivat e use, unlike t he benef it char ge f or car s.
The van r ules will change f r om 2007/ 08. A van wit h unr est r ict ed pr ivat e use will have a f lat r at e benef it of £ 3,000 r egar dless of t he age of t he van. I n addit ion t her e will be a scale char ge of £ 500 wher e f uel f or pr ivat e use is pr ovided by t he employer .
D6.2 Mobile phones s.319
I f an employer pr ovides an employee wit h a mobile phone, t his is a tax exempt benef it even if t he employer is paying f or t he employee’s per sonal t elephone calls.
It is quite common in practice for employees, par t icular ly t hose who ar e not of f ice based, t o be pr ovided wit h a company mobile phone. The Revenue r ecognises t hat t her e will inevit ably be some per sonal calls made by t he employee but t hey have chosen not t o t r eat t his as a t axable benef it .
The exempt ion only cover s t he “pr ovision f or an employee.....of a mobile phone”. Ther ef or e if an employee has his own mobile phone and t he employer r eimbur ses any pr ivat e calls or st anding char ges t her e will be a t axable benef it equal t o t he cost t o t he employer of r eimbur sing such expenses.
336 Principles of Business Taxat ion ‘Finance Act 2006’
Fr om 2006/ 07 onwar ds t he number of mobile phones t hat can be loaned wit hout giving rise to a benefit is restricted to one per employee; t here will be no exempt ion f or phones loaned t o t he member of t he employees f amily or household.
D6.3 Vouchers
I f an employer pr ovides voucher s t o an employee – f or example a high st r eet st or e s.87 voucher – t her e will be a t axable benef it . The cash equivalent will be t he cost to the employer of providing the voucher t o t he employee. This is common at Chr ist mas wher e employer s of t en give bonuses t o employees in t his f or m.
Wher e an employer pr ovides meal vouchers to an employee, this is also a taxable s.89 benefit except t hat t he first 15 pence per day of vouchers pr ovided is exempt f r om t ax. So, if t he employer gives a one pound meal voucher t o an employee, only 85 pence of t his is t axable.
Similar ly if an employee is pr ovided with some form of “credit token” – for example, a cr edit car d, debit car d or ot her t oken or document giving t he employee s.90 t he r ight t o obt ain goods or ser vices – t he cost of pr oviding such a t oken will be a t axable benef it f or t he employee.
D6.4 Mileage allowances s.229
Mileage allowances will be paid when an employee uses his own car for work pur poses. When an employer pays a mileage allowance t o t he employee, he is
r eimbur sing t hat employee at a f ixed amount per mile f or using his own car . The s.229(4) mileage allowances r ules do not t her ef or e apply t o company vehicles.
The Revenue want t o make sur e t hat t he employee is not making a pr of it f r om t he mileage allowance paid t o him. I f t her e is a pr of it – i.e. t he cost t o t he employee of using his car is less t han t he allowance paid – t he Revenue will t ax t hat pr of it as employment income.
To wor k out t he pr of it , t he Revenue has tax-exempt limits which we need t o apply. I f allowances ar e paid above t hese limit s t he employee will be making a pr of it – if allowances ar e paid below t hese limit s, t he employee will be making a loss.
The t ax-exempt limit s depend on t he employee’s business mileage in t he year . Remember that business mileage does not include travelling from home to work. I f an employer r eimbur ses an employee’s t r avel cost s f r om home t o wor k, t his will be a f ully t axable benef it .
Miscellaneous Benef it s 337
The limit s ar e given in t he Tax Tables pr ovided wit h your cour se and ar e also r epr oduced below.
Vehicles Fir st 10,000 Addit ional Business miles Business miles Car s 40p 25p Mot orcycles 24p 24p Bicycles 20p 20p
Not e f r om t he t able t hat t he t ax-exempt limit s change once t he business mileage t hr eshold of 10,000 miles has been exceeded.
Remember t hat t he point of t his scheme is t o det er mine whet her t he employee is making a pr of it or loss f r om using his own car f or wor k. To det er mine t he pr of it , we simply t ake t he allowance r eimbur sed and deduct t he t ax-exempt limit . Prof it s ar e t axable whilst losses ar e deduct ible.
Illustration 1
An employee owns his own car f or occasional business j our neys. I n t he t ax year t he employee did 15,000 business miles. His employer r eimbur ses him at a f ixed r at e of 60 pence f or ever y business mile t r avelled. The calculat ion is as f ollows:
£ Reimbur sed 15,000 x 60p 9,000 Less: t ax exempt limit s 10,000 x 40p (4,000) 5,000 x 25p (1,250) Taxable prof it £3,750
Illustration 2
I f t he employee in t he illust r at ion above was r eimbur sed at a lower r at e of 20 pence per mile, t he calculat ion is as f ollows: £ Reimbur sed 15,000 x 20p 3,000 Less: t ax exempt limit s 10,000 x 40p (4,000) 5,000 x 25p (1,250) Loss (deduct ible f r om ear nings) £(2,250)
The t axpayer is allowed t o deduct t his loss f r om his ot her t axable ear nings f or s.231 t he year .
I n pr act ice, many employer s make sur e t hat t hey r eimbur se t heir employees at a r at e exactly equal to the tax exempt limits, so year on year employees using t heir own car s f or business pur poses will neit her have a pr of it nor a loss.
338 Principles of Business Taxat ion ‘Finance Act 2006’
D6.5 Passenger payments s.233
I n an at t empt t o encour age dr iver s t o shar e business j our neys wher ever possible, t he Revenue has int r oduced a scheme wher eby payments can be made free of tax and NI C t o an employee carrying one or more passengers.
“Passenger payment s” can be made t ax exempt t o an employee if : • t he dr iver and passenger (s) ar e fellow employees making t he same business j our ney; and • t he “passenger payment s” do not exceed t he “appr oved amount ” of 5p s.234 per business mile; and • t he employee physically receives the passenger payment f r om t he employer (i.e. an employee who is not paid ext r a f or car r ying passenger s cannot claim an addit ional 5p per mile allowance).
Only payment s in r espect of business mileage ar e t ax-f r ee – t he passenger payment scheme does not ext end t o pr ivat e mileage such as home t o of f ice t r avel.
The “passenger allowance” applies per passenger (eg 10p per business mile f or 2 passenger s et c) and applies t o bot h company vehicles and f or employees using t heir own car s f or business pur poses.
D6.7 Tax exempt benefits
There is a long list of benef its which are completely exempt f rom tax. Here we will pick up a dozen or so of t he mor e f amiliar t ax exempt benef it s.
One of t he most valuable benef it s t hat employees r eceive f r om t heir employer s, is s.307 an employer’s contribution to the employee’s pension scheme. This is exempt f r om t ax as long as t he pension scheme has Revenue appr oval.
Ther ef or e if an employer pays int o eit her t he employee’s occupat ional pension scheme or int o t he employee’s per sonal pension scheme, no t axable benef it will ar ise. The level of employer ’s cont r ibut ions is ir r elevant .
The pr ovision of a mobile phone and associated calls is a t ax-exempt benef it . s.319
The reimbursement of removal expenses is exempt, up to a maximum amount of £8,000. For example, if an employee is t ransf er r ed t o anot her of f ice and t he employer pays t he r elocat ion expenses, no t axable benef it will ar ise as long as t he s.287 cost of t he move is less t han £ 8,000.
The exempt ion applies t o “r emoval benef it s” and t o t he “payment or r eimbur sement of r emoval expenses”. Such expenses will qualif y if t hey ar e “r easonably pr ovided in connect ion wit h a change in t he employee’s r esidence” – i.e. in r espect of a change in t he dut ies and/ or locat ion of t he employment or on t he employees becoming employed.
Miscellaneous Benef it s 339
Qualif ying r emoval expenses will include: • legal f ees in connect ion wit h t he acquisit ion of a new r esidence (including st amp dut y land t ax); • any such abor t ive acquisit ion cost s; • legal f ees in connect ion wit h t he disposal of a f or mer r esidence; • cost s of t r anspor t ing belongings (including t empor ar y st or age cost s); • t r avel and subsist ence f or t he employee (and f amily) t o visit t he new ar ea.
A det ailed br eakdown of allowable cost s is given at s.277 – s.283 I TEPA 2003.
Qualif ying r emoval expenses will also include t he addit ional int er est paid on a br idging loan t aken out bet ween buying a new pr oper t y and disposing of an old one. s.284
The pr ovision by t he employer of a cr èche or nur ser y f or employee’s childr en is a t ax-exempt benef it . The f acilit ies must usually be exclusively f or t he employer . s.318
Ther e is a par t ial exempt ion of up t o £ 55 a week f or childcare vouchers. This s. 318A also applies t o ot her childcar e wher e t he employer cont r act s directly with the childcar e pr ovider such as a commer cial nur ser y.
The pr ovision of “wor kplace par king” is a t ax-exempt benef it . This cover s not j ust a space in t he employer ’s car par k but would also ext end t o t he cost s of a season t icket at a public car par k close t o wor k. Similar ly t he pr ovision of mot or cycle or s.237 bicycle spaces at or near wor k is a t ax-exempt benefit.
Subsidised st af f cant eens ar e t ax-exempt benef it s as long as t he cant een f acilit ies ar e available t o all employees. Ther ef or e if a company has a cant een or r est aur ant t hat is r eser ved f or use by senior execut ives only, t hose execut ives will s.317 have a t axable benef it on t he cost s of t he f r ee or subsidised meals pr ovided.
Incidental expenses paid by an employer t o employees wor king away f r om home ar e t ax exempt up t o a daily limit . These limit s ar e £ 5 per night while wor king in s.240 & s.241 t he UK and £10 per night whilst working abroad.
Cost s incur r ed by t he employer in pr oviding f ull t ime, day r elease or block r elease t r aining ar e t ax-exempt benef it s. SP4/ 86
The pr ovision by t he employer of a Chr ist mas par t y or ot her similar f unct ion f or t he employees, will not give r ise t o a t axable benef it f or t he employees as long as t he cost s of t he par t y did not exceed £ 150 per head. This will mean t hat f or most s.264 of f ice par t ies, t her e will be no cor r esponding t ax char ge on t he employees. SI However , if t he employer t hr ows a par t icular ly lavish part y which cost s, say, £ 200 2003/ 1361 per head, t he t axable benef it f or each employee will be t he f ull £ 200 and not j ust t he excess over £ 150. I t is an all or not hing benefit.
Awar ds by an employer t o an employee f r om a st af f suggest ion scheme ar e s.321 gener ally t ax exempt pr ovided t hat t he awar d does not exceed £ 5,000. & s.322
340 Principles of Business Taxat ion ‘Finance Act 2006’
Long ser vice awar ds of up t o £ 50 per year of ser vice, as long as t he employee had at least 20 year s ser vice wit h t he same employer ar e also exempt . This exempt s s.323 SI 2003/ gif t s such as gold wat ches et c t o a long ser ving employee on r et ir ement . 1361
Employer s can make t ax-exempt payment s t o an employee in r espect of r easonable
addit ional cost s incur r ed f or wor king at home. This must be under a homewor king s.316A ar r angement wher e t he employee r egular ly wor ks at home.
Ther e is no limit t o such payment s st ated in st at ut e. However , t he Revenue has st at ed t hat no r ecor ds need t o be kept by employer s f or payment s up t o £ 2 per week or £ 104 per year . I f payment s exceed t hese limit s, t he employer should keep r ecor ds t o pr ovide evidence t hat t he higher payment s wer e wholly in r espect of addit ional household expenses incur r ed by t he employee in wor king f r om home.
This cover s t he most common t ax exempt benef it s but it is by no means a def init ive list .
Ot her benef it s which ar e t ax exempt include: - wor kplace spor t s or r ecr eat ional f acilit ies f or use by st af f gener ally s.261 -“t hir d par t y benef it s” – i.e. benef it s f r om someone ot her t han one’s s.324 employer not exceeding £ 250 per year . SI 2003/ 1361 - lat e night t axis et c when t he employee is occasionally r equir ed t o wor k lat e (i.e. af t er 9 pm) s.248 - hospit alit y or ent er t aining if pr ovided by someone ot her t han t he employer s.265 - eye t est s or cor r ect ive glasses where an employee is r equir ed t o use a visual-display unit (VDU) in t he employment
Example 1
Which of t he f ollowing benef it s ar e t ax exempt in 2006/ 07?
a) Use of company van b) £ 500 loan t o buy annual t r avelcar d c) £ 40 per week childcar e voucher s d) Car par k voucher near wor k e) Employer payment t o wor k pension scheme f) Loan of comput er cost ing £ 1,000 in May 2006
Example 2
Rodney uses his own car f or wor k. I n 2006/ 07 he did 25,000 miles, half of which were f or business pur poses. His employer r eimbur sed Rodney at 40p f or each business mile.
Calculat e Rodney’s t axable benef it .
Miscellaneous Benef it s 341
Answer 1
Tax exempt Taxable
a) Use of company van b) £ 500 t r avelcar d loan c) £ 40 per week childcar e voucher s d) Car par k voucher e) Payment t o pension scheme f) Loan of comput er
Answer 2
£ £ Mileage r eimbur sed 12,500 @ 40p 5,000
Less: t ax exempt limit s 10,000 @ 40p 4,000 2,500 @ 25p 625 (4,625) Taxable pr of it £375
342 Principles of Business Taxat ion ‘Finance Act 2006’
SUMMARY - MISCELLANEOUS BENEFITS
I f an employee is pr ovided wit h a company van, the benef it is £ 500 f or the year. I f the van is ≥ 4 year s old at t he end of t he t ax year t he benef it is £ 350. These r ules ar e changing f r om Apr il 2007.
I f an employee is given voucher s, t he cost of pr oviding t hese is t axable as a benef it . However t he f ir st 15p per day of meal voucher s is exempt f r om t ax.
I f t he employer r eimbur ses t he employee f or business mileage incur r ed using his own car , t he amount r eimbur sed must be compar ed wit h t he t ax exempt limit s set by t he Revenue.
I f t he amount r eimbur sed exceeds t he limit s t his excess is t axable. I f it is less t han t he limit s, t he short f all is deduct ible.
Ther e ar e a number of t ax exempt benef it s including:
Employer cont r ibut ions t o an appr oved pension scheme Mobile phones (only one per employee) Removal expenses up t o £ 8,000 Exclusive nur ser y up t o £ 55 per week childcare vouchers/ ot her direct ly provided childcare Car par king at or near t he place of wor k St af f cant eens pr ovided available t o all employees I ncident al expenses f or wor king away f r om home (£ 5 in UK, £ 10 if abr oad) Tr aining cost s Chr ist mas par t y or ot her f unct ions cost ing below £ 150 per head St af f suggest ion scheme awar ds up t o £ 5,000 Long ser vice awar ds up t o £ 50 per year of ser vice if ser ved at least 20 year s Addit ional cost s of wor king f r om home under a homewor king ar r angement
D7: EXPENSES OF EMPLOYMENT
I n t his chapt er you will lear n how t o t r eat payment s r eceived f r om t he employer in r espect of expenses including: - expenses t hat ar e ‘wholly, exclusively and necessarily’ incurred; - qualif ying t r aveling expenses - pr of essional f ees and subscr ipt ions; - payr oll deduct ion scheme.
D7.1 Introduction
I n t his chapt er we shall look at t he expenses t hat ar e allowed as a deduct ion in ar r iving at net t axable ear nings. Bef or e we do so, let ’s r emind our selves wher e t hey f it int o t he ear nings pr of or ma.
Cash r emuner at ion X Benef it s X X Less: exempt income (X) Taxable ear nings X Less: allowable deductions (X) Net t axable ear nings X
We st ar t wit h cash r emuner at ion such as salar y and bonuses. We also need t o add any expenses r eimbur sed t o t he employee by t he employer . All expenses paid by an employer t o an employee ar e t r eat ed in t he f ir st inst ance as cash ear nings – i.e. money r eceived by t he employee. To t his we add any benef it s.
At t his point we can t ake a deduct ion f or any allowable deduct ions. Taxable ear nings less allowable deduct ions gives net t axable ear nings f or the year. I t is t his f igur e t hat goes int o t he income t ax comput at ion as non-savings income.
Allowable deduct ions br oadly f all int o f ive main cat egor ies.
a) Expenses deduct ible under s.336 ITEPA 2003. b) Tr avel expenses (s.337 – s.340 I TEPA 2003).
c) Payment s made by an employee to an occupational pension scheme - the det ailed r ules wit h r egar d t o pension cont r ibut ions will be dealt wit h in a lat er chapt er .
d) Professional fees or subscriptions paid t o an or ganisat ion appr oved by t he Revenue.
e) Donations made by an employee t o charity under t he Payr oll Deduct ion Scheme.
344 Principles of Business Taxat ion ‘Finance Act 2006’
D7.2 Section 336 – “deductions for expenses: the general rule”
Sect ion 336 lays out t he gener al r ules f or deduct ions t o be made f r om t axable s.336 ear nings. A deduct ion under t he gener al r ules is allowed if :
a) t he employee is obliged to incur and pay the expense as holder of the employment ; and b) t he amount is incur r ed “wholly, exclusively and necessarily” in t he per f or mance of t he dut ies.
I n or der t o ascer t ain whet her an expense is deduct ible, we t her ef or e need t o look closely at t he t er ms “wholly, exclusively and necessarily”.
The wor d “necessar ily” is t he biggest obst acle t o us when t rying t o persuade t he Revenue t hat expenses ar e allowable. The quest ion t he Revenue will ask us is “could t he employee do his j ob wit hout incur r ing t hat par t icular expense?”.
I f t he answer t o t his quest ion is “yes” – i.e. he could do his j ob if t hat expense had not been incur r ed – t he Revenue will ar gue t hat t he expense is not absolutely necessary and is not therefore deductible f r om t axable ear nings.
However , if t he answer is “no” – i.e. he cannot do his job without incurring that expense - t he expense will be necessar y f or t he per f or mance of t he dut ies and will t her ef or e be allowable.
The Revenue ar e ver y st r ict in applying t his r ule and it is notoriously difficult for employees to get relief for expenses under Section 336. Lat er on we will have a look at a couple of t ax cases, and you will see t hat t he Revenue have been successf ul mor e of t en t han t he t axpayer and most disput ed claims f or expenses have been disallowed.
D7.3 Travel expenses
Sect ions 337 and 338 deal wit h t he deduct ibilit y of t r avel expenses. Under s.337-338 gener al pr inciples a deduct ion f or t he employee’s t r avel cost s will be allowed if t he expenses ar e:
(i) necessarily incurred on t r avelling in t he per f or mance of t he dut ies of t he employment ; or (ii) at t r ibut able t o t he employee’s necessary attendance at any place in t he per f or mance of t he dut ies of t he employment .
Sect ion 338 specif ically denies a deduct ion f or “expenses of ordinary commuting”. “Or dinar y commut ing” in t his cont ext is def ined as t r avel bet ween either:
a) t he employee’s home and a permanent workplace; or b) a place t hat is not a wor kplace (eg a hot el or someone else’s home) and a per manent wor kplace.
Expenses of Employment 345
This means t hat if an employee incur s t r avel expenses in going f r om his home t o his normal place of work, t hese expenses will not be allowable, as t hey const it ut e expenses of or dinar y commut ing. You will be awar e of t his alr eady as your employer does not r eimbur se you f or home t o of f ice t r avelling and you do not get t ax r elief f or t hese cost s.
No deduct ion is allowed f or t r avel bet ween any t wo places t hat is, f or pr act ical pur poses, substantially ordinary commuting. This means t hat if an employee, f or inst ance, is r equir ed t o at t end a t r aining college and t he j our ney t o t he college is subst ant ially t he same as t hat t o t he usual place of wor k (and at a similar expense), no deduct ion will be allowed f or t r avel cost s t o t he college.
However , once at wor k, if an employee incur s expenses in t r avelling f r om his nor mal place of wor k t o visit a client, t hat is not “or dinar y commut ing” but is inst ead t r avel in t he per f or mance of t he dut ies and as such t hese expenses will be deduct ible. Ther ef or e, office to client travel is allowable.
But what if t he employee t r avels dir ect ly f r om his home t o a client ’s pr emises and doesn’t go int o t he of f ice f ir st ? The Revenue have accept ed t hat t hese t r avel expenses ar e allowable as t hey ar e not or dinar y cost s of commut ing but only pr oviding t hat t he client ’s pr emises const it ut e a “temporary workplace”.
A “t empor ar y wor kplace” is def ined as a place which t he employee at t ends in t he s.339 per f or mance of his dut ies in or der to perform a task of limited duration or f or some ot her t empor ar y pur pose.
A wor kplace will not be “t emporary” if the employee attends for a period of continuous work lasting more t han 24 mont hs. Ther ef or e if an employee is visit ing a client f or a day, or a f ew days or even a f ew mont hs, t he client pr emises will be a “t empor ar y wor kplace” and t r avel t o and f r om t hat wor kplace will be deduct ible expenses.
A “t empor ar y wor kplace” may become a “per manent workplace” if eit her: a) t he employee has wor ked at t hat locat ion f or a cont inuous per iod of 24 mont hs; or b) it becomes appar ent t hat t he absence f r om t he or iginal per manent wor kplace will exceed 24 mont hs.
I n t hese inst ances, t r avel cost s up t o t he point of “change” ar e deduct ible, but cost s af t er t hat dat e ar e not .
An “ar ea” could be r egar ded as a per manent wor kplace and t r avel cost s t o and f r om t hat ar ea would not be deduct ible. An “area based employee” is one whose s.339(8) employment dut ies ar e def ined by r ef er ence t o an “ar ea” (r at her t han a specif ied sit e or building) and wher e t he employee at t ends dif f er ent places in t he ar ea in t he cour se of his j ob.
346 Principles of Business Taxat ion ‘Finance Act 2006’
Cer t ain “site based” employees will have no per manent wor kplace and will t r avel t o var ious dif f er ent “sit es” t o per f or m t heir dut ies. Providing t hat a j ob at a par t icular sit e is not expect ed t o last mor e t han 24 mont hs, cost s of t r avelling f r om home t o sit e (and back again) will be deduct ible.
Finally, t he Revenue do not accept t hat an employee whose employment cont r act is I RPR for less than 24 months is by definition t r avelling t o and f r om a t empor ar y 16.5.95 s.339(5) wor kplace. Deduct ions f or t r avel cost s in t hese inst ances will be denied. (a)(ii)
D7.4 Professional fees and subscriptions
A deduct ion f r om t axable ear nings is allowed f or an amount paid by an employee in s.343 r espect of a professional fee. The deduct ion is allowed pr ovided t hat t he employment involves the practice of the profession to which the fee relates and t he payment of t he f ee is a condition which must be met if that profession is t o be pr act iced.
Sect ion 343 cont ains a list of deduct ible f ees and t hese include pr act ice f ees f or doct or s, dent ist s, opt icians, vet s, lawyer s, ar chit ect s and t eacher s.
A deduct ion f r om t axable ear nings is also allowed f or annual subscriptions paid t o s.344 an “approved body”. The Revenue has a published list of such bodies. The subscription will be deductible as long as the activities of the body are of direct benef it t o, or concer n t he pr of ession pr act iced in, t he per f or mance of t he dut ies.
For example, a subscr ipt ion by a company director to the I nstitute of Directors would be deduct ible because t he subscr ipt ion r elat es t o t he employment and is to an approved body. However if the same director then paid a subscription to his local golf club, t his would not be deductible as t his has not hing t o do wit h t he employment .
The Revenue would not accept an ar gument t hat it is “necessary” f or t his employee t o be a member of t he golf club, even t hough he may meet client s and do some business at t he club. This was t est ed in t he t ax case of Br own v Bullock wher e a bank manager ' s Gent leman’s Club f ees wer e disallowed by t he cour t s on t he gr ounds t hat t hey wer e not absolut ely necessar y. He could do his j ob as a bank manager wit hout being a member of t he club. The f act t hat his club member ship occasionally won him some business was held t o be ir r elevant .
D7.5 Charitable donations s. 713
Ther e ar e t wo met hods of obt aining t ax r elief on char it able donat ions.
As we have seen alr eady, t he f ir st is via t he Gift Aid scheme. Gift Aid payments are made net of basic rate tax and we give higher rate relief by ext ending t he basic r at e band by t he gr oss amount of t he donat ion.
Expenses of Employment 347
The second way in which a t axpayer can get t ax r elief on a donat ion t o char it y is by using t he Payr oll Deduct ion Scheme. You may also see t his r ef er r ed t o as t he Give As You Earn (GAYE) scheme.
Donat ions ar e made gross – i.e. t her e is no wit hholding of basic r at e t ax at sour ce. This gr oss donat ion is deducted from taxable earnings f or t he year.
I n pr act ice, t he gr oss donat ion is deduct ed by t he payr oll depar t ment bef or e PAYE is applied t her eby giving t he employee t ax r elief as he goes along. The employer will t hen pass on t he amount s wit hheld t o t he relevant charit y.
D7.6 Employee liabilities and indemnity insurance s.346
I f an employee pays a pr emium under a qualif ying insur ance cont r act , t hat pr emium is deduct ible f r om t axable ear nings. A qualif ying insur ance cont r act is essent ially a cont r act which pr ovides f or t he employee t o be indemnif ied against any cost s or damages ar ising f rom act ion t aken against him.
Most employer s will have t heir own Prof essional I ndemnit y I nsur ance which cover s t he act ions of t heir employees, so f ew employees will need t o consider t aking out an indemnit y policy f or t hemselves.
D7.7 Reimbursed expenses
Most business expenses incur r ed by employees will be r eimbur sed by t heir employer s at a lat er dat e when t he employee makes an expense claim. As f ar as t he t ax comput at ion is concer ned, we need t o do t wo t hings.
Fir st we treat the expenses reimbursed by the employer to the employee as earnings from the employment - i.e. we include t his payment t o t he employee’s t axable ear nings. As such, t he amount r eimbur sed should be r ef lect ed by t he employer as a benef it on t he employee’s P11D.
Having t r eat ed t he r eimbur sed expense as income, we need t o determine whether that expense can be deducted t o ar r ive at next t axable ear nings.
I t will be allowable if it is eit her wholly, exclusively & necessarily incurred in t he per f or mance of t he dut ies, or if it is a qualifying travelling expense or it is a pr of essional f ee or subscr ipt ion. I n t hese cases, t he expense can be deduct ed f r om t axable ear nings.
I n t he case of genuine business expenses, t he amount which goes int o t he comput at ion as income and t he amount t hat is deduct ed as an allowable expense, will cancel out leaving not hing t axable.
348 Principles of Business Taxat ion ‘Finance Act 2006’
This will not be t he case however if t he expense is not wholly, exclusively & necessar ily incur r ed in t he per f or mance of t he dut ies. I n t his case, no deduct ion will be allowed f or t he expense and t he amount r eimbur sed by t he employer will be t axed in t he same way as a benef it . This will be t he case if per sonal expenses ar e r eimbur sed by t he employer .
D7.8 Dispensations s.65
A “dispensat ion” is a not ice pr ovided by t he Revenue t o an employer agr eeing that no additional tax will be payable by an employee who r eceives cer t ain payment s or benef it s. The payment s in quest ion will be genuine business expenses r eimbur sed by t he employer t o t he employee.
I n t he absence of a dispensat ion, expenses r eimbur sed t o an employee will be t r eat ed as earnings in t he f ir st inst ance and ent er ed on f or m P11D. The employee will t hen be lef t t o claim r elief f or t he expense via his self assessment r et ur n.
I f an employer makes an applicat ion f or dispensat ion, t his unnecessar y “paper chase” can be avoided.
Illustration 1
Chr is makes a business t r ip t o Edinbur gh and his r et ur n t r ain t icket cost s £ 75. When he r et ur ned t o t he of f ice, he made an expense claim and his employer , Online Tut or s Lt d, r eimbur sed t his £ 75.
Chr is is employed on a salar y of £ 25,000. St rict ly what should happen is t hat t he expenses r eimbur sed of £ 75 should be t r eat ed as income, and t he employer should pr oduce a f or m P11D f or Chr is including t his £ 75 as a benef it . Chr is’s t ot al ear nings f or t he year will now be £ 25,075.
As f ar as Chr is is concer ned, t he £ 75 is a qualif ying t r avelling expense and is t her ef or e deduct ible f r om his t axable ear nings. He will make a claim under s.337 on his t ax r et ur n and t he £ 75 will be deduct ed, leaving Chr is wit h t axable income s.337 of £ 25,000. This is exact ly t he same as t he salary f igure so you will see t hat t he t wo ent r ies of £ 75 have cancelled each ot her out .
£ Salary 25,000 Add: r eimbur sed expense 75 Taxable ear nings 25,075 Less: t r avel expenses (75) Net t axable ear nings £ 25,000
What we have achieved is to create a lot of paperwork with no end result. The company has t o pr epar e a P11D t o show a benef it of £ 75, and Chr is has t o pr epar e a t ax r et ur n t o claim t his amount as an expense of his employment .
Expenses of Employment 349
This is a wast e of t ime, so in t hese cir cumst ances t he Revenue will issue a not ice of nil liabilit y or dispensat ion t o t he employer in r espect of t he business t r avelling expenses. This means t hat t he employer her e can ignor e t hese t r avel expenses when pr epar ing P11Ds.
Employer s must apply to their local Tax Office for dispensations, and dispensat ions ar e issued by t he I nspect or in r espect of specif ic cat egor ies of expendit ur e – business t r avel being t he most common.
Not e t hat if an employer does not have a dispensation for a particular type of expense, such expenses r eimbur sed t o employees must be reflected on the P11D and t he employee will t hen make a claim via his t ax ret urn if he t hinks t he expense is deduct ible.
D7.9 Round Sum Allowances
A r ound sum allowance is a gener al allowance – usually a f ixed amount of cash – paid t o t he employee in advance t o cover his or her expenses f or a par t icular per iod. For example, Online Tut or s Lt d could pay a r ound sum of £ 1,000 t o Chris t o cover f or t hcoming expenses.
A round sum allowance should be t r eat ed in t he f ir st inst ance as salar y and t he employer should withhold tax under PAYE. This will nor mally happen aut omat ically as t he payment is of t en made via t he payr oll syst em. Ther e is no way ar ound t his as t he I nland Revenue will not issue dispensat ions f or r ound sum allowances.
Chr is will spend t he money on var ious it ems and will claim a deduct ion, via his end of year t ax r et ur n, f or any amount s spent f or business pur poses – i.e. any expenses incur r ed wholly, exclusively & necessar ily in t he per f or mance of his dut ies.
One impor t ant t hing t o be awar e of here is that the Revenue do not regard expenses incurred in entertaining customers or clients as genuine business s.356 expenses. Ther ef or e if Chr is spends par t of his r ound sum allowance on client ent er t aining, no deduct ion will be allowed.
However , r elief f or t he ent er t aining expense will be allowed if the amount falls to be disallowed in comput ing t he employer ’s t axable t r ading pr of it s as will be t he s.357 case f or client ent er t aining. I n t his case, t he employee will be able t o t ake a deduct ion f or t he ent er t aining cost s in calculat ing net t axable ear nings.
The above r est r ict ion f or “client ” ent er t aining does not apply t o expenses of s.358 ent er t aining fellow employees. These cost s ar e gener ally f ully deduct ible.
350 Principles of Business Taxat ion ‘Finance Act 2006’
Example 1
Mr Br oker (a Cit y analyst ) incur s t he f ollowing expenses:
a) Tube f ar e t o wor k b) Taxi f are f rom of f ice to client c) Payment t o company pension scheme d) Financial Times t o r ead on t he t ube e) Subscr ipt ion t o t he I nst it ut e of St ockbr oker s f) Pinst r ipe suit and br aces f or of f ice.
Which of t hese expenses ar e deduct ible in ar r iving at net t axable ear nings?
Expenses of Employment 351
Answer 1
Allowable Not Allowable a) Tube f ar e t o wor k X b) Taxi f are t o client c) Pension payment d) Financial Times (see Not e 1 below) X e) Subscr ipt ion t o I nst it ut e of St ockbr oker s f) Pin st r ipe suit and br aces (see Not e 2 below) X
Not e 1
Mr Br oker ’s newspaper cost s will not be allowed by t he Revenue. Mr Br oker would ar gue t hat , as a st ockbr oker , it is necessar y f or him t o r ead t he Financial Times on a daily basis, but a similar claim has alr eady been hear d and r ej ect ed by t he cour t s.
I n t he case of Smith v Abbott, a j our nalist f or a nat ional daily newspaper ar gued t hat it was necessar y f or him t o buy and r ead t he daily newspaper s of his compet it or s in or der t o do his j ob.
The cour t s agr eed wit h t he Revenue and disallowed t his expense as it was held not t o be absolut ely necessar y as it was possible f or t his j our nalist t o do his j ob wit hout incur r ing t hat expense.
The cour t s said t hat t he expendit ur e simply enabled t he employee t o do his j ob bet t er and t his was not enough t o pass t he st r ingent t est s laid down in s.336.
Not e 2
The Revenue have again been successf ul bef or e t he cour t s in ar guing t hat t he cost s of suit s et c ar e not allowable on t he gr ounds t hat t he expense is not exclusively f or t he per f or mance of t he dut ies.
The cour t s have said t hat we buy clot hing not j ust f or business pur poses but also t o pr ovide us wit h war mt h and decency and hence t he expense has a dualit y of pur pose and is not allowable.
Deduct ions will only be available f or such t hings as pr ot ect ive clot hing or cost umes or unif or ms – i.e. clot hing which could not be wor n in an ever yday cont ext .
352 Principles of Business Taxat ion ‘Finance Act 2006’
SUMMARY - EXPENSES OF EMPLOYMENT
Any amount s r eceived f r om an employer in r espect of expenses incur r ed ar e included as par t of t axable ear nings.
A deduct ion will t hen be given if t he expense was ‘wholly, exclusively and necessar ily’ incurred which is a st rict t est .
Qualif ying t r avelling expenses ar e also deduct ible but t hese exclude or dinar y commut ing (ie home t o wor k). Tr avel f r om t he of f ice or f r om home t o a t empor ar y wor kplace (less t han 24 mont hs) will be deduct ible.
Prof essional f ees and subscr ipt ions ar e deduct ible pr ovided t hey ar e paid t o an appr oved body.
Payment s t o char it y can be made via t he Payr oll Deduct ion Scheme wher eby t he payment is made gross and is deduct ed f rom salary bef ore applying PAYE t o give relief . This is an alt er nat ive t o obt aining r elief via Gif t Aid.
Reimbur sed expenses ar e br ought in as t axable ear nings unless t he employer has a dispensat ion which saves including them on the P11D only for them to be claimed as a deduct ion lat er .
Round sum allowances will always be t axable in t he f irst inst ance but a deduct ion can be claimed f or what is spent on allowable expenses. This however excludes any amount spent on client ent er t aining, unless t he amount has been disallowed in t he employer ’s t ax calculat ion.
D8: CALCULATING THE INCOME TAX LIABILITY
I n t his chapt er you will lear n how t o use a pr of or ma f or calculat ing income t ax on non savings income including: - t he per sonal allowance; - t he r at es of t ax f or non savings income; - t ax deduct ed at sour ce.
Ref er ences in t his chapt er ar e t o t he I ncome & Cor porat ion Tax Act 1988 (I CTA 1988) unless ot her wise st at ed.
D8.1 Introduction The f ir st st ep in calculat ing an individual’s t ax liability f or the tax year 2006/ 07, is t o ar r ive at t axable income f or t he year . Having ar r ived at t axable income, we t hen apply 2006/ 07 t ax r at es t o t hat income t o give a t ax liabilit y f or t he year.
The pr of or ma f or calculat ing an individual’s t ax liabilit y is ver y impor t ant .
The income t ax pr of or ma dif f er ent iat es bet ween three different types of income. The f ir st t ype of income is non-savings income. Non-savings income essent ially means income f r om employment , income f r om self employment and r ent al income.
The second f or m of income is bank or building society interest and t he t hird and f inal f or m of income r eceived by individuals is dividend income.
We separ at e t hese t hr ee f or ms of income wit hin t he comput at ion because t hey ar e t axed in dif f er ent ways and at dif f er ent r at es.
D8.2 Proforma income tax calculation Non savings Interest Dividends
Ear nings X
Tr ading income X Proper t y income X I nt er est X
Dividends X
For eign income X X X Total income T T T Less: Char ges on income (X) ______St at ut or y t ot al income STI STI STI
354 Principles of Business Taxat ion ‘Finance Act 2006’
For eign income could be non-savings income if it ar ose f r om r ent s in a villa in Spain. I t could also be interest income if it was bank interest on a Jersey bank account . I t could also be dividend income if it was dividends on shar es in an Amer ican company. Ent r ies could t her ef or e be made in t he non-savings column, t he int er est column or in t he dividend column.
I ncome f r om all sour ces is t hen added t oget her t o give t ot al income. Cer t ain expenses incur r ed by individuals can be deduct ed in or der t o ar r ive at t axable income. These expenses ar e called charges on income.
Char ges on income ar e deduct ed f r om non-savings income first, alt hough if t her e is insuf f icient non-savings income, char ges can be deduct ed f r om int er est and t hen f r om dividends as appr opr iat e. Total income less charges on income gives us “St at ut or y Tot al I ncome” or STI.
St at ut ory t ot al income (STI ) is not t he same as t axable income. Fr om st at ut or y t ot al income we deduct the personal allowance f or t he year in or der t o ar r ive at t axable income.
Non Savings Interest Dividends Statutory Total Income X X X Less: Per sonal Allowance (PA) __ __ Taxable I ncome X X X
As wit h char ges on income, t he per sonal allowance is deduct ed f r om non-savings income in priorit y t o int erest and in priorit y t o dividend income. Having deduct ed t he per sonal allowance f r om t he STI , t his gives us t axable income f r om all sour ces.
The personal allowance f or the tax year 2006/07 is £5,035. s. 257
The per sonal allowance is available t o all individuals who ar e r esident in t he UK, and cer t ain individuals who ar e r esident abr oad. A per sonal allowance is given t o ever ybody, even t o childr en.
Illustration 1
Mr Br own has t he f ollowing income and expendit ur e f or 2006/ 07:
£ Salary f rom his j ob 30,000 Benef it s f r om his employment 8,000 Rent s f r om f lat in Br ight on 7,000 Rent s f r om chat eau in Fr ance 4,500 Char ge on income paid (1,000)
Calculat ing t he I ncome Tax Liabilit y 355
Mr Br own’s t axable income is calculat ed as f ollows:
Non Savings £ I ncome f r om ear nings (30,000 + 8,000) 38,000 Proper t y income 7,000 For eign income 4,500 49,500 Less: Char ge on income (1,000) Statutory Total Income (STI) 48,500 Less: Per sonal Allowance (5,035) Taxable Income £43,465
D8.3 Calculating the tax liability
To calculat e an individual’s t ax liabilit y, we st ar t by looking at how non-savings income is t axed f or t he t ax year .
Thr ee r at es of t ax apply t o non-savings income.
We have a lower r at e of 10%, a basic r at e of 22% and a higher r at e of 40%.
HI GHER RATE Excess 40% £ 33,300
BASI C RATE Next
22% £ 31,150
£ 2,150 Fir st LOWER RATE £ 2,150 10% £0
TAXABLE I NCOME
The f ir st £ 2,150 of an individual’s t axable income is char ged t o t ax at t he lower r at e of 10%.
The next chunk of an individual’s income is charged at the basic rate of tax, which is 22%. The basic r at e applies t o t axable income bet ween £ 2,150 and £ 33,300. As you will see, t his gives us a basic r at e band of £ 31,150.
356 Principles of Business Taxat ion ‘Finance Act 2006’
For individuals wit h t axable income in excess of £ 33,300, t he higher rat e of t ax applies. This is cur r ent ly 40%. This applies t o all t axable income in excess of t he basic r at e t hr eshold.
Remember t hat t he 10%, 22% and 40% rates apply t o non-savings income only. Dif f er ent r at es apply t o int er est and dividends, as we shall see lat er .
Illustration 2
Cont inuing t he pr evious illust r at ion, Mr Br own’s t ax liabilit y is calculat ed as f ollows:
Taxable I ncome £ 43,465
Tax £ 2,150 @ 10% 215 31,350 @ 22% 6,853 10,165 @ 40% 4,066 43,465 ______Tax liabilit y £11,134
D8.4 Tax already paid
Any income t ax which Mr Br own has alr eady paid dur ing t he cour se of t he year can be deduct ed f r om t ax liabilit y t o give a f inal f igur e of t ax due and payable t o t he Revenue. The t ax due will be collect ed by t he Revenue under t he self assessment r egime.
I f t he t ax paid at sour ce in t he t ax year exceeds t he t ax liabilit y, t he t axpayer will be due an income t ax r epayment f r om t he Revenue.
Illustration 3
Assume that Mr Brown from the previous illust r at ion had paid t ax on his employment income under t he Pay As You Ear n (PAYE) syst em of £ 9,000. This £9,000 can be deducted from the tax liability to give a figure of tax due as f ollows: £ Tax liabilit y 11,134 Less: PAYE (9,000) Tax due £2,134
Calculat ing t he I ncome Tax Liabilit y 357
Example 1
Mr s Whit e has t he f ollowing income/ expenses in 2006/ 07:
£ Ear nings f r om employment (gr oss) 32,000 (PAYE deduct ed £ 6,000) Rent f r om apar t ment in New Yor k 9,500 Char ge on income paid (1,200)
Calculat e her I ncome Tax due.
Example 2
Mr Green has t he f ollowing income in 2006/07:
£ Salary (PAYE £3,000) 12,000 UK r ent al income 3,500 Premium bond winnings 2,000
Calculat e his income t ax due/ r epayable.
358 Principles of Business Taxat ion ‘Finance Act 2006’
Answer 1
Non Savings £ Ear nings 32,000 For eign income 9,500 Less: Char ge on income (1,200) STI 40,300 Less: Per sonal allowance (5,035) Taxable I ncome £ 35,265
Tax £ 2,150 @ 10% 215 31,150 @ 22% 6,853 1,965 @ 40% 786 Tax liabilit y 7,854 Less: t ax paid under PAYE (6,000) Tax due £1,854
Answer 2
Non savings £ Ear nings 12,000 Proper t y I ncome 3,500 Premium bond winnings Exempt STI 15,500 Less: Per sonal allowance (5,035) Taxable I ncome £ 10,465
Tax £ 2,150 @ 10% 215 8,315 @ 22% 1,829 Tax liabilit y 2,044 Less: PAYE deduct ed (3,000) Tax r epayable t o Mr Green £(956)
Calculat ing t he I ncome Tax Liabilit y 359
SUMMARY - CALCULATING THE INCOME TAX LIABILITY
Taxable income is calculat ed by combining all sour ces of income, deduct ing char ges on income paid and f inally deduct ing t he per sonal allowance which is £ 5,035 f or 2006/ 07.
Non savings income is t hen t axed as f ollows:
First £ 2,150 at 10% Next £ 31,150 at 22% Rest at 40%
Finally any tax paid at source, such as PAYE, is deducted to find the tax due or r epayable f or t he year .
D9: INTRODUCTION TO PAYE
I n t his chapt er you will lear n about t he PAYE syst em which collect s t ax f r om employment income including: - what PAYE applies t o; - how t he syst em wor ks; - t ax codes; - under payment s of t ax; - K codes.
St at ut or y r ef er ences in t his chapt er ar e t o I TEPA 2003 unless st at ed ot her wise.
D9.1 Introduction
The Pay As You Earn (or PAYE) syst em is a met hod by which t ax is deduct ed f rom employment income at sour ce. PAYE is not a t ax in it self – it is simply a syst em s. 684 under which t ax on employment income and Nat ional I nsur ance is t aken f r om SI 2003/ 2682 salar ies at t he point of payment and handed over t o t he Revenue.
PAYE schemes ar e oper at ed by employer s. The Revenue use employer s as unpaid t ax collect or s on t heir behalf . I f employer s f ail t o oper at e PAYE cor r ect ly t her e ar e penalt ies f or t hese f ailur es.
The PAYE syst em aims t o r ecover t ax and Nat ional I nsur ance wher ever “PAYE income” is paid t o an employee. Nat ional I nsur ance Cont r ibut ions ar e paid by bot h employer s and employees and we shall take a detailed look at NIC in a separ at e chapt er .
The PAYE r egulat ions also cont ain det ailed pr ovisions wit h r egar d t o t he collect ion and r ecover y of t ax and NI C, t he r et ent ion and pr oduct ion of r ecor ds, int er est and penalt ies f or compliance f ailur es and PAYE appeal pr ocedur es.
PAYE must be applied at t he “t ime of payment ”. The dat e at which PAYE income is s. 684 (2) “paid” is def ined in Section 686 as t he ear lier of : s. 686
(i) t he t ime when payment is made; and (ii) t he t ime when t he per son becomes ent it led t o t he payment .
Ther e ar e special r ules f or dir ect or s as discussed in Chapt er 15.
Employer s pay t he PAYE t ax and NI C t o t he Revenue on a mont hly basis on t he 19th of each mont h. The due date f or payment is 14 days after t he end of the tax month of payment , and each t ax mont h ends on t he 5th of t he mont h.
I nt roduct ion t o PAYE 361
Ther e is one except ion t o t his. I f t he t ot al t ax and Nat ional I nsur ance
Cont r ibut ions payable by t he employer ar e less t han £ 1,500 per mont h on SI 2003 aver age, t he employer has t he opt ion t o make payment s under PAYE on a / 2682 quar t er ly basis. For t his pur pose, t he f our t ax quar t er s end on 5 J uly, 5 Reg. 70 Oct ober, 5 J anuar y and 5 Apr il, so PAYE payment s ar e due 14 days af t er each of t hose quar t er ends.
D9.2 PAYE income
I TEPA 2003 def ines “PAYE income” in s.683. I t consist s of :
(i) PAYE employment income (see below).
(ii) PAYE pension income (e.g. payment s by employer s t o f or mer employees under pension schemes); and
(iii) PAYE social secur it y income (e.g. St at ut ory Sick Pay and St at ut ory Mat er nit y Pay paid by employer s t o r elevant employees).
We ar e most ly concer ned wit h PAYE employment income which consist s of :
(i) any t axable ear nings f r om an employment in t he year ; and
s.696 (ii) any t axable specif ic income f r om an employment in t he year . s.702
This def init ion t her ef or e cover s most cash payment s made by employer s t o employees including salar ies, bonuses and t er minat ion payment s.
Ther e ar e some cash payment s made by an employer t o an employee t hat will not be subj ect t o PAYE. The main example is t he payment of excluded business expenses. These ar e expenses which would not give r ise t o a t axable benef it which t he I nland Revenue has aut hor ised t he employer t o ignor e.
PAYE is not just restricted to payments in cash. Payments to employees in the f or m of “readily convertible assets” ar e also subj ect t o PAYE. A “r eadily conver t ible asset ” is an asset which is t r adeable on a r ecognised St ock or Commodit ies Exchange. These asset s will include quot ed shar es – i.e. shar es listed on a r ecognised St ock Exchange – or gold bullion.
For example, if an employee wor ks f or Mar ks & Spencer plc, and as par t of his r emuner at ion he is given shar es in Mar ks & Spencer plc, as t hese shar es ar e list ed on t he UK St ock Exchange, t hey ar e r eadily conver t ible asset s and t ax at sour ce under PAYE would have t o be deduct ed f r om t he payment .
A r eadily conver t ible asset also includes any asset f or which t r ading ar r angement s exist . A t r ading ar r angement basically means t hat t he employer has ar r anged f or t he employee t o be able t o sell t he asset which has been awar ded t o him – ie, t he employer ar r anges f or t he employee t o r eceive cash f rom a t hird part y in ret ur n f or t he asset .
362 Principles of Business Taxat ion ‘Finance Act 2006’
For example, let us say t hat as par t of an employee’s r emuner at ion, his employer gives a br and new Fer r ar i. Ther e is no r ecognised Commodit ies Exchange f or Fer r ar is, but if , as par t of t he deal, t he employer has ar r anged wit h a t hir d par t y f or t he employee t o be able t o sell t hat Fer r ar i and r eceive cash in r et ur n, t he asset is a r eadily conver t ible asset and PAYE will have t o be applied t o t he payment .
Normal benefits such as t he use of a company car or a taxable cheap loan or living accommodation, ar e not gener ally subj ect t o deduct ion of t ax at sour ce under PAYE. These benef it s ar e usually ent er ed on form P11D and t ax is paid on t hese benef it s at t he end of t he year under Self Assessment .
However , as we shall see lat er , in or der t o pr event t her e f r om being a lar ge under payment of t ax on benef it s at t he end of t he year , t he Revenue usually t ax benef it s via t he employee’s t ax code. We shall deal wit h t ax codes lat er on in t his chapt er.
D9.3 How the PAYE system works
Once t he employer has ar r ived at t he employee’s PAYE income f or a par t icular ear nings per iod – t he most common ear nings per iod being t hat of one mont h – t his income is ent er ed on t o a PAYE deduct ion car d. The employer t hen calculat es t ax on t he income using t he employee’s tax code.
The pur pose of a t ax code is f or t he Revenue t o t ell t he employer what allowances et c., ar e due t o t he employee. All of us will be ent it led t o t he basic per sonal allowance so we can ear n a cer t ain amount of t ax f r ee pay ever y mont h. This t ax f r ee pay is deduct ed f r om t he PAYE income and t he excess is char ged t o t ax.
The employer calculat es t he pr ecise amount of t ax due using t ax t ables. These t ables ar e pr ovided by t he Revenue and t her e ar e separ at e t ables f or t ax and Nat ional I nsur ance Cont r ibut ions.
The employer looks at t he mont hly gr oss pay, t hen looks at t he employee’s t ax code and wher e t hese t wo point s meet on t he t ax t ables, t hat is t he income t ax t o be deduct ed f or t hat par t icular mont h. What t he t ables ef f ect ively do is t o t ake gross pay, deduct some personal allowances, and char ge t he excess at 10%, at 22% and, if r elevant , at 40%.
Once t he employer has ar r ived at t he t ax and t he Nat ional I nsur ance t o be deduct ed, t his is wit hheld f r om gr oss pay and t he net amount is paid t o t he employee.
I t is t he employer ’s r esponsibilit y t o keep r ecor ds of all PAYE income paid t o employees and of t he t ax and Nat ional I nsur ance deduct ed f r om t hat income. These pay and t ax det ails will be r ecor ded on var ious r et ur ns sent t o t he Revenue at t he end of t he year . PAYE Ret ur ns will be dealt wit h in t he next chapt er .
I nt roduct ion t o PAYE 363
D9.4 Tax Codes
The tax code is issued by t he Revenue t o employers on form P6.
A det ailed br eakdown of how t he Revenue has ar r ived at t he tax code is given t o the employee on a dif f er ent f or m - form P2. Not e her e t hat t he employer only r eceives t he “bot t om line” f igur e – i.e. t he employer does not r eceive t he det ailed br eakdown of t he code as t his is conf ident ial inf or mat ion given t o t he employee only.
The pur pose of t he t ax code is t o t ell t he employer how many allowances or reliefs t he employee is ent it led t o. These allowances will include per sonal allowances, age allowances and any ot her r elief s such as qualif ying int er est or EI S relief et c.
The t ax code will also t ake account of any benef it s t o which t he employee is ent it led. The t ax code t akes t he employee’s allowances f or t he year , deduct s any benef it s t he employee has f or t he year and t he dif f er ence is t he net allowances due t o t he employee.
Allowances f or year X Benefits (X) Net allowances due X
These net allowances ar e t he employee’s t ax f r ee pay. By r est r ict ing an employee’s allowances by t he amount of his benef it s, what t he Revenue ar e doing is ef f ectively taxing benef its on a monthly basis as they go along. The Revenue do t his t o pr event t he employee having a large t ax bill at t he end of t he year.
Illustration 1
Mr J ones is ent it led t o a per sonal allowance in 2006/ 07 of £ 5,035. I n t he t ax year he also receives some benefits f rom his employer. He has a company car wit h a benef it of £ 1,690. He is also pr ovided wit h pr ivat e f uel f or t hat car , giving r ise t o a benef it of £ 2,240.
Tax code: £ £ Per sonal allowance 5,035 Benef it s: Car benef it 1,690 Fuel benef it 2,240 (3,930) Net allowances £1,105
Tax Code 110L
364 Principles of Business Taxat ion ‘Finance Act 2006’
The Revenue will conver t t his t ax f r ee pay of £ 1,105 int o a t ax code. To do t his t hey will simply knock of f t he end f igur e – i.e. r emove t he 5 – and r eplace t hat number wit h t he let t er L. So t he t ax code here is 110L. The suffix L simply means t hat Mr J ones is ent it led t o t he nor mal Per sonal allowance.
I n pr act ice you may be asked by your client t o check t he det ailed br eakdown of t he code t o make sur e t hat t he allowances and t he benef it s wit hin t he t ax code ar e cor r ect .
What you ar e doing is simply checking t hat t he Revenue ar e deduct ing mor e or less t he cor r ect amount of t ax each mont h under PAYE. Any ext r a t ax owed t o t he Revenue, or any r epayment s due t o t he t axpayer , will be dealt wit h once t he Self Assessment r et ur n has been submit t ed.
Not ices of Coding can t ake account of allowances ot her t han t he basic per sonal allowance. For example, t hey can t ake account of t ax r educer s such as subscr ipt ions t o EI S companies and any mar r ied couples r elief due t o older t axpayer s. The codes can also t ake account of Gif t Aid donat ions and any cont r ibut ions t o pension schemes which at t r act t ax r elief . Tax codes ar e also ver y commonly used t o deal wit h t ax under or over payment s f r om pr evious year s.
The t ax code can also be used t o t ax small amount s of ot her income likely t o ar ise in t he t ax year , such as r ent al or invest ment income. However , a t axpayer can obj ect t o t his income being encoded.
D9.5 Underpayments of tax
PAYE is not an exact science, so the amount of tax deducted at source under PAYE will not always be exact ly t he same as t he t ax liabilit y f or t he year. Most t axpayer s in t he UK will eit her have small under or over payment s at t he year end.
I f t he t ax due f or t he year is less t han £ 2,000, t he Revenue do not r equir e t his t ax t o be paid under Self Assessment on 31 January. I nst ead t hey are happy t o collect t his t ax a lat er t ax year under PAYE. For example, if t he under payment occur s in 2006/ 07, t he Revenue will usually adj ust t he t ax code in 2008/ 09.
The idea is t hat t he employee will pay slight ly more t ax in t he lat er year t o cancel out t he t ax under payment f r om t he ear lier year .
Illustration 2
Mr Wood is employed on a salar y of £ 20,000 per annum and has benef it s of £ 500. I n 2004/ 05 Mr Wood had a t ax under payment of £ 150.
I nt roduct ion t o PAYE 365
Mr Wood’s t ax code f or t he t ax year 2006/ 07 is calculat ed as shown:
£ Per sonal allowance 5,035 Benef it s (500) Tax underpaid 2004/ 05 100 (682) £ 150 x 22 Net allowances £3,853
Tax Code 385L
This calculat ion r equir es some explanat ions. We will st ar t wit h Mr Wood’s allowances. He has a nor mal Per sonal allowance of £ 5,035.
Mr Wood’s benef it s f or t he year ar e £ 500, so t hese are deduct ed. I n 2004/ 05 Mr Wood had a small under payment t hat we need t o deal wit h via his t ax code. What we need t o do here is t o rest rict Mr Wood’s allowances by such an amount so as t o cr eat e an ext r a t ax liabilit y of £ 150 in 2006/ 07.
As Mr Wood is a basic rate taxpayer, we do this by multiplying by 100 over 22 giving £ 682. We ar e ef f ect ively pr et ending t hat in 2006/ 07 Mr Wood has extra income of £682. When multiplied by the basic rate of 22%, this will creat e an ext ra t ax liabilit y of £ 150. This is t he t ax t hat he owes f or t he pr evious year .
The net allowances due f or t he year ar e t he t ot al allowances less t he benef it s, giving £ 3,853. We t hen knock of f t he f inal 3 and r eplace t hat wit h t he let t er L f or nor mal per sonal allowances t o give Mr Wood a t ax code f or t he year of 385L.
D9.6 K Codes
A “K” code is a negat ive code and will ar ise wher e benef it s exceed allowances for the year. So wher eas in t he case of a nor mal code an employee has an amount of t ax f r ee pay each mont h, wher e an employee has a “K” code this will actually increase the taxable pay.
I f an employee has a nor mal Per sonal allowance and t otal benef its of £ 8,000 f or t he year his code will be as f ollows: £ Per sonal allowance 5,035 Benef it s (8,000) Negat ive allowance £ (2,965)
Tax code K295
A “K” code is so-called because t he code is pr ef ixed by t he let t er K. Her e we t ake £ 2,965, we r emove t he f inal 5 t o give us 296, and t hen t he Revenue deduct one t o give 295. The Revenue t hen put a “K” on t he f r ont so t hat t he code becomes K295.
366 Principles of Business Taxat ion ‘Finance Act 2006’
This will be not if ied t o t he employer by t he Revenue on f or m P6. This t ells t he employer t o incr ease t he employee’s PAYE income by a cer t ain amount each mont h, so as t o ef f ect ively t ax t he benef it s at sour ce. This pr event s a lar ge t ax under payment f r om ar ising at t he end of t he year .
When a K code is used, t he maximum amount of tax that can be deducted in any period cannot exceed 50% of gross pay. For example, if an employee has gross cash pay of £3,000 in a month, the maximum amount of tax that can be deduct ed under PAYE is £ 1,500. This is t o pr event har dship - i.e. t o pr event an employee’s cash pay f r om being t ot ally wiped out in t ax.
The sole pur pose of t he code is t o det er mine how much t ax an employee pays each year under PAYE. I f you t hink back t o your income t ax comput at ion, you always t ax gr oss ear nings and t hen deduct t ax alr eady paid under PAYE at t he bottom to give you a f igure of tax due or tax repayable. As f ar as is possible, t he Revenue will t r y t o make t he t ax deduct ed under PAYE mor e or less equal t o t he employee’s t ax liabilit y f or t he year by using t he t ax code syst em. However t hey under st and t hat PAYE codes cannot be t ot ally accur at e, so small under or over payment s ar e inevit able.
I f on r eceiving his f or m P2, an employee t hinks t hat his t ax code is incorrect , t he employee can make an appeal t o t he Revenue. The appeal can be made in wr it ing or , t he employee can t elephone t he Tax Of f ice and ask t hem t o change t he t ax code.
Example 1
Which of t he f ollowing ar e PAYE income?
a) Per f or mance r elat ed bonus b) St at ut ory sick pay c) Company car d) Non t axable business expenses e) Bonus paid in silver bullion f) Compensat ion f or loss of of f ice.
Example 2
Alber t was 73 on 1 Febr uar y 2006. He is mar r ied t o Elsie who is 69.
Alber t has a par t t ime j ob paying £ 12,000 per annum
He has no benef it s and no ot her income.
Calculat e what his t ax code f or 2006/ 07 will be.
I nt roduct ion t o PAYE 367
Answer 1
PAYE income? a) Per f or mance r elat ed bonus b) St at ut ory sick pay c) Company car X d) Non-t axable business expenses X e) Bonus in silver bullion f) Compensat ion f or loss of of f ice
Answer 2
£ Per sonal age allowance 7,280 Mar r ied couples r elief £ 6,065 x 10% = £ 607 Given as 100 2,759 607 x 22 Tot al allowances £10,039
Tax Code 1003V
Albert is 73 and so is ent it led t o Personal Age allowances. He is married so he is also ent it led t o Mar r ied Couples r elief as he was bor n bef or e 6 Apr il 1935. Alber t has a salar y of £ 12,000 and no ot her income. This means t hat as his STI is less t han £ 20,100, t hese allowances ar e given in f ull wit h no r est r ict ion.
Alber t ’s Mar r ied Couples r elief will be £ 6,065 at 10%. Mar r ied Couples r elief is given as a t ax r educer so we need t o f act or t his in t o Albert ’s t ax code. We t her ef or e need t o incr ease Alber t ’s allowances by such an amount t hat it saves Albert t ax of £ 607. As Albert is a basic rat e t axpayer we do t his by mult iplying by 100 over 22.
This has t he ef f ect of giving Albert addit ional allowances of £ 2,759. The idea is t hat by incr easing Alber t ’s allowances by £ 2,759, we save him t ax at 22% giving r ise t o a t ax saving of £ 607.
Adding t hese t oget her gives Alber t t ot al allowances of £ 10,039. We r emove t he last digit t o give us a t ax code of 1003 and t his t ime we add t he suf f ix “V” which denot es age r elat ed Mar r ied Couples allowances. So Alber t ’s t ax code will be 1003V.
(Not e: t he var ious coding suf f ixes (“L”, “V” et c) ar e not impor t ant f or examinat ion pur poses).
368 Principles of Business Taxat ion ‘Finance Act 2006’
SUMMARY - INTRODUCTION TO PAYE
PAYE is t he syst em by which employer s collect tax on employment income paid to their employees and pass it on t o t he I nland Revenue.
PAYE is due on the 19th of the month, but can be paid quarterly if the amount is less t han £ 1,500 per mont h on aver age.
Most cash payment s ar e subj ect t o PAYE but it also applies t o r eadily conver t ible asset s being asset s t r adeable on a r ecognised exchange or wher e t r ading ar r angement s exist .
The employer uses t he employee’s t ax code and some t ax t ables t o calculat e t he t ax and NI C due each mont h.
The t ax code r epr esent s t he per sonal allowances t hat t he employee is ent it led t o, and is r educed by benef it s.
A r educt ion in t he t ax code can also be made t o collect t ax under paid in an ear lier year .
K codes occur when benef it s exceed allowances. The maximum t ax t hat can be collect ed via such a code is 50% of gr oss pay.
D10: PAYE END OF YEAR RETURNS
I n t his chapt er you will lear n about t he PAYE end of year r et ur ns including: - f or ms sent t o t he Revenue; - f or ms given t o t he employee; - due dat es; - int er est ; - penalt ies f or a lat e r et ur n; - penalt ies f or an incor r ect r et ur n.
D10.1 Introduction
A number of end of year return f orms have to be f iled by the employer to the Revenue. I t is t he employer ’s r esponsibilit y t o provide cert ain det ails t o t he Tax Of f ice at t he end of t he year, and t here ar e a var iet y of specif ic f or ms t o enable t he employer t o do so.
The f or m P60 cont ains det ails of t axable ear nings paid by an employer t o an employee in t he year along wit h det ails of any t ax and Nat ional I nsur ance deduct ed f r om t hose ear nings. The P60 will also cont ain basic det ails such as t he employer ’s name and addr ess and t he employee’s Nat ional I nsur ance number .
The P60 is given by the employer to the employee no later than 31 May following the end of the tax year. The employee will t hen use t he det ails on t he P60 t o pr epar e his own Self Assessment t ax r et urn.
The employer will also complet e a form P14 for each employee. The det ails on t he P14 ar e t he same as t hose on t he P60. The dif f erence here is t hat t he P14 is given by the employer to the Revenue.
All t he f or ms P14 ar e ef f ect ively r olled t oget her t o f or m an end of year summary which is called t he f orm P35. The P35 summar ises all t he individual deduct ion sheet s f or each and ever y employee.
For ms P14 and P35 must be submit t ed by t he employer t o t he Revenue no lat er SI 2003/ 2682 t han 19 May f ollowing t he end of t he t ax year . Par a 73
A f orm P11D is pr ovided t o ever y higher paid employee who r eceives benef it s in t he t ax year . A higher paid employee is any employee who ear ns mor e t han £ 8,500 per annum. I f benefits are provided to lower paid employees, t hese ar e summar ised on form P9D.
Each of t hese f or ms cont ains det ails of t he cash equivalent of each benef it pr ovided. The deadline f or t he submission of f orms P11D and P9D t o t he Revenue SI 2003/ 2682 is 6 J uly f ollowing t he end of t he t ax year . The employer will give a copy of t he Par a 85 P11D t o t he employee t o enable t he employee t o put t oget her his Self Assessment Ret ur n.
370 Principles of Business Taxat ion ‘Finance Act 2006’
A f orm P45 is given by t he employer t o ever y employee who leaves that particular employment. P45s ar e also pr ovided in r espect of employees whose employment t er minat es as a r esult of deat h.
The f or m P45 has f our par t s. The employer will send the f irst part of the f orm t o t he Revenue and give t he ot her t hr ee par t s of t he f or m t o t he employee. The employee will keep one par t of t he P45 f or his own r ecor d pur poses and give t he ot her t wo par t s of t he f or m t o his new employer . The new employer f ills in det ails of t he new employment , t hen keeps one par t of t he P45 f or his own r ecor d pur poses. The employer sends t he f inal par t t o t he Revenue.
The P45 cont ains det ails of pay and t ax f rom the start of the tax year to the dat e t he employment t er minat ed. The P45 also cont ains t he code number oper at ed by t he pr evious employer . This code number will t hen be oper at ed by t he new employer unt il a new one is issued by t he Revenue.
I n cer t ain cir cumst ances, an employee will be asked t o f ill in a f orm P46. A P46 is complet ed by employees who j oin an employer but do not have a P45. This will be t he case if t his is t he employee’s f ir st j ob since leaving educat ion or if t he employee has anot her j ob and does not have a f or m P45.
The f or m P46 will ask t he employee t o cer t if y one of t wo t hings.
a) I f t he employee cer t if ies t hat t his is his f ir st or main j ob t he employer will oper at e an “emer gency code”. This emer gency code f or 2006/ 07 will be 503L, which means t hat when t he employer deduct s t ax under Pay As You Ear n, t he employee will simply be given t he nor mal Per sonal allowance as his t ax f r ee amount .
b) I f t he employee cer t if ies on f or m P46 t hat t his employment is neit her his f ir st j ob nor his main j ob, t he employer will oper at e code BR. This means t hat t ax will be deduct ed f r om ear nings at t he basic r at e of 22% wit hout any per sonal allowances being given.
D10.2 Interest
Tax and Nat ional I nsur ance should be paid over t o t he Revenue no lat er t han t he 19th of each month. I f an employer makes t hese payment s lat e, t he Revenue will char ge t he employer int er est on t he lat e paid t ax. The r ules her e however ar e quit e gener ous in t hat interest does not start to run until 19 April following the end of the tax year.
So in r espect of t ax due f or t he t ax year 2006/ 07, if t he employer st ill owes t he Revenue some t ax f or t his t ax year t hen int erest will run f rom 19 April 2007 t o t he dat e bef or e t he t ax is act ually paid. This means t hat as long as t he employer has paid all of his t ax and Nat ional I nsur ance due under PAYE 19 Apr il f ollowing t he end of t he t ax year , t hen no int er est char ge will be levied.
I f t ax has been over paid by t he employer and a r epayment of t ax is due, t hen r epayment supplement will r un f or t he same per iod.
PAYE End of Year Ret urns 371
D10.3 Penalties
I t is t he employer ’s obligat ion t o oper at e Pay As You Ear n cor r ect ly and if he f ails t o do so, t he Revenue has t he r ight t o char ge a penalt y. Penalt ies will be char ged eit her if t he employer sends in his end of year Ret ur ns lat e, or if t hose Ret ur ns ar e incor r ect .
D10.4 Late Returns s. 98A TMA 1970
For ms P35 and P14 ar e due f or submission on 19 May f ollowing t he end of t he t ax year . However t he Revenue has conf ir med t hat , by concession, t hey will not charge a penalty if the P35 or P14 is submitted within 7 days of the normal due date.
I f t he P35 or P14 is mor e t han 7 days lat e, t he penalt y will be £100 per month (or par t mont h) for each group of up to 50 employees. So f or example, if a f or m P35 is one mont h lat e and t he company has 110 employees, t he penalt y will be £ 100 mult iplied by 1 mont h mult iplied by 3 - 110 employees const it ut ing 3 separ at e gr oups of 50 employees. This penalt y is f ixed and cannot be mit igat ed at t he discr et ion of t he I nspect or .
I f t he r et ur ns ar e more than 12 months late, a further penalty of up to 100% of the tax unpaid at that time may also be levied.
For ms P11D or P9D should be submit t ed no later than 6 July following the end of the tax year. I f t hese f or ms ar e lat e, t he Revenue can char ge an initial penalty of up t o £300 per late form and can thereafter char ge a f ur t her penalt y of up t o £60 per day f or each day t hat t he f ailur e cont inues. These penalt ies can be mit igat ed at t he discr et ion of t he Revenue.
D10.5 Incorrect Returns s. 98A TMA 1970
I f an employer f iles an incor r ect f or m P35 or P14, t he maximum penalt y t hat may be charged is up t o 100% of any t ax or Nat ional I nsurance lost as a result of t he er r or . This is not a f ixed penalt y and it can be r educed by t he Revenue depending on t he f act s and cir cumst ances of each case.
The penalty f or submit t ing an incorrect form P11D or form P9D is up to £3,000 for each incorrect form. This means that if an employer provides benef it s t o 100 employees and get s each of t he f or ms P11D wr ong, t he Revenue could char ge a penalt y of £ 3,000 t imes 100 - i.e. a t ot al penalt y of £ 300,000.
372 Principles of Business Taxat ion ‘Finance Act 2006’
D10.6 Recovery of tax SI 2003/ 2682 Reg 80
Wher e an employer fails to operate Pay As You Earn correctly, and t his r esult s in an under payment of t ax, t he Revenue can eit her r ecover t he t ax f r om t he employer or f r om t he employee. I n t he maj or it y of inst ances t he Revenue will choose t o r ecover t he t ax f r om t he employer by using a Regulation 80 determination.
Having quant if ied t he t ax under paid, t he Revenue will issue a not ice under Regulation 80 of the PAYE Regulations. The employer has a right to appeal this det er minat ion if he t hinks it is incorrect but if no appeal is lodged, the det er minat ion becomes f inal and conclusive wit hin 30 days.
I f t he Revenue ar e sat isf ied t hat t he employer t ook r easonable car e t o comply wit h t he PAYE Regulat ions and any under payment of t ax ar ose due t o an er r or Reg 72 made in good f ait h, t he Revenue will inst ead seek r ecover y of t he t ax f r om t he employee.
The Revenue will also seek collect ion of t he t ax f r om t he employee if t hey have r eason t o believe t hat t he employee accept ed his ear nings in t he f ull knowledge t hat t he employer had under deduct ed t ax. Remember t hat int er est will always r un on lat e paid t ax f r om 19 Apr il f ollowing t he t ax year t o t he dat e bef or e payment is made.
D10.7 Electronic filing Tax Bullet in No. 63 The Revenue has st at ed t hat all employers will be required t o f ile t heir End of Year r et ur ns (P14s, P35s, P11Ds, et c) elect ronically by 2010. This can be done eit her dir ect ly by t he employer or via an int er mediar y such as a payr oll bur eau or agent .
“Lar ger ” employer s (t hose wit h 250 or mor e employees) wer e r equir ed t o “e-f ile” t heir year end ret urns by May 2005. Many wer e doing so alr eady, so f or lar ger employer s t his was not an addit ional bur den.
The compulsor y elect r onic f iling dat e will t her eaf t er depend on t he number of s.135 & s.136 employees t he employer has: FA2002
Number of employees Fir st compulsor y elect r onic Ret ur n Deadline 250+ Tax year 2004/05 May 2005 50-249 Tax year 2005/06 May 2006 Under 50 Tax year 2009/10 May 2010
A penalt y will be levied f or a f ailur e t o comply wit h t hese deadlines. This will be £3,000 per annum per PAYE scheme for an employer’s failure to make an elect r onic r et ur n. This penalt y is in addit ion t o t he usual ar r ay of penalt ies f or lat e f iling.
PAYE End of Year Ret urns 373
“Small” employer s (t hose wit h f ewer t han 50 employees) will be of f er ed f inancial incent ives t o encour age t hem t o make an ear ly t r ansit ion t o e-f iling. These ar e as f ollows:
End of year r et ur n I ncent ive £ 2004/ 05 250 2005/ 06 250 2006/ 07 150 2007/ 08 100 2008/ 09 75
This income is not t axable.
Example 1
By what dat e must t he employer f ile his f or m P35 f or 2006/ 07 t o avoid a penalt y being char ged?
Example 2
Tar dy Lt d has 63 employees.
The Finance Dir ect or sends t he f or m P35 f or 2006/ 07 t o t he Revenue on 27 July 2007.
What will t he penalt y char ged on Tar dy Lt d be?
374 Principles of Business Taxat ion ‘Finance Act 2006’
Answer 1
The nor mal due dat e f or t he submission of a P35 is 19 May f ollowing t he end of t he year . However t he Revenue allow a 7 day per iod of gr ace, so long as t he P35 is submit t ed by 26 May 2007 no penalt y will be char ged.
Answer 2
Due dat e f or P35 was 19 May 2007 Filing dat e was 27 J uly 2007 So P35 was j ust over 2 mont hs lat e – t his equals 3 mont hs
Penalt y £ 100 per mont h per gr oup of up t o 50 employees 63 employees is 2 gr oups
£ 100 x 3 mont hs x 2 = £600
PAYE End of Year Ret urns 375
SUMMARY - PAYE END OF YEAR RETURNS
The main end of year r et ur ns t o be submit t ed ar e as f ollows:
P60 Given t o employee, det ails of t ot al pay and deduct ions Due by 31 May P14 As P60 but given t o Revenue Due by 19 May P35 Summar y of all t he P14s given t o t he Revenue Due by 19 May P11D Given t o employee and Revenue, summar y of benef it s Due by 6 July given t o a higher paid employee P9D As above but f or lower paid employee Due by 6 July
The P45 is pr epar ed when an employee leaves. One par t is given t o t he Revenue, t hr ee par t s ar e given t o t he employee who keeps one and gives t he ot her t wo t o t he new employer .
A new employer f ills in det ails of t he new employment on t he P45 and sends one par t t o t he Revenue and keeps t he ot her .
I f no P45 is available, a P46 is complet ed by t he new employee. The employer will use t he emer gency code if it is t he employee’s f ir st j ob, or t he BR code if it is a second j ob.
I nt er est r uns on lat e paid PAYE and NIC f r om 19 Apr il f ollowing t he t ax year .
Lat e r et ur ns at t r act penalt ies. For t he P14 and P35 t her e is a gr ace per iod of 7 days.
P14/ P35 > 7 days lat e £ 100 per mont h per 50 employees > 12 mont hs lat e 100% of t he t ax unpaid P11D/ P9D if late I nitially £ 300 per f orm or £ 60 per day if f ailur e cont inues
I ncor r ect P14/ P35 at t r act s a penalt y of 100% of t he t ax lost . I ncor r ect P11D/ P9D penalt y is £ 3,000 per f or m.
I f PAYE is operated incorrectly any underpayment can be collect ed f r om t he employer via a Regulat ion 80 det er minat ion. This becomes f inal if not appealed wit hin 30 days.
The Revenue ar e encour aging businesses t o move t o elect r onic f iling f or year end r et ur ns. All employer s must e-f ile r et ur ns f or t he t ax year 2009/ 10 onwar ds.
D11: CLASS 1 NATIONAL INSURANCE CONTRIBUTIONS
I n t his chapt er you will lear n about Class 1 NI C including: - an over view of t he six classes of NI C; - def init ion of ear nings; - Class 1 pr imar y cont r ibut ions; - rules f or direct ors; - Class 1 secondar y cont r ibut ions; - cont r act ing out of St at e Second Pension.
Ref er ences in t his chapt er ar e t o Social Secur it y Cont r ibut ions & Benef it s Act (SSCBA) 1992 unless st at ed ot her wise.
D11.1 Introduction
NI C is a ver y impor t ant money-r aising t ool f or t he Tr easur y and, year on year , Nat ional I nsur ance Cont r ibut ions br ing in around 20 to 21 per cent of total Government revenue. Collection of NI C is administ er ed by t he Nat ional I nsur ance Cont r ibut ions Of f ice (NI CO) which is now par t of t he HM Revenue and Cust oms. Ot her par t s of t he HMRC assist NI CO in t he collect ion of Nat ional I nsur ance Cont r ibut ions, par t icular ly via t he PAYE syst em.
The pur pose of Nat ional I nsur ance Cont r ibut ions is t o pr ovide cer t ain r et ir ement benef it s such as t he St at e Pension, as well as t o f und cer t ain Social Securit y benef it s such as J ob Seeker s Allowance and I ncapacit y Benef it . I f t he amount raised by NICO by way of National Insur ance Cont r ibut ions is insuf f icient t o cover t hese benef it s, any def icit is made up by a gr ant f r om t he Tr easur y.
At pr esent t her e ar e six classes of Nat ional I nsur ance:
a) Class 1 - paid by bot h employees and employer s on ear nings f r om employment . s. 1 b) Class 1A - paid by employer s only on benef it s awar ded t o employees. c) Class 1B - paid by employer s only on Pay As You Ear n Set t lement Agr eement s (PSAs). d) Class 2 - paid by self -employed per sons on t he pr of it s f r om t heir t r ade. e) Class 3 - volunt ar y cont r ibut ions paid by t axpayer s who wish t o t op-up t heir cont ribut ion record in order t o pr eser ve t heir ent it lement t o St at e benef it s. f) Class 4 - paid by self -employed per sons on t he pr of it s f r om t heir t r ade. Classes 2 and 4 will be cover ed in t he business t ax sect ion of your cour se.
This gives us an overview of National Insurance. In this chapter we shall concent r at e solely on Class 1 NI C.
Class 1 Nat ional I nsur ance Cont r ibut ions 377
s. 2 D11.2 Class 1 NIC
Class 1 Nat ional I nsur ance Cont r ibut ions ar e br oken down int o primary cont r ibut ions or secondary cont r ibut ions. Primary cont r ibut ions ar e paid by employees whilst secondary cont r ibut ions ar e paid by employers.
Class 1 NI Cs ar e paid on ear nings f r om t he employment . I f an employee r eceives ear nings, t hat employee will pay Class 1 pr imar y cont r ibut ions whilst if an employer pays ear nings t o an employee, t he employer makes a secondar y Class 1 cont r ibut ion.
Bot h pr imar y and secondar y cont r ibut ions ar e account ed f or under t he PAYE syst em and ar e paid over t o t he Revenue, along wit h income t ax, on t he 19th of each month.
Ever y t ime an employer makes a payment of ear nings t o an employee, t hat employer will have t o account f or Class 1 secondar y NI Cs cur r ent ly at a r at e of 12.8%. This is a ver y subst ant ial addit ional cost bor ne by employer s and t he maj or it y of NI Cs r aised by t he Tr easur y ar e collect ed f r om employer s r at her t han employees.
D11.3 Earnings s. 3
Class 1 cont r ibut ions ar e paid on “ear nings”. I t is ver y impor t ant t hat we est ablish what const it ut es “earnings” f or Nat ional I nsur ance pur poses. Any cash payment made by an employer t o an employee is likely t o be ear nings f or NI C pur poses. This will include salar ies and bonuses but will not include t he r eimbur sement of genuine business expenses.
I f an employer makes a non-cash payment t o an employee – i.e. some f or m of payment in kind – and t hat payment in kind can be surrendered for cash, that payment will also be earnings f or NI C pur poses.
A payment in t he f or m of a pr emium bond f or example, will const it ut e ear nings f or NI C because t he employee can t ake t he pr emium bond t o t he Post Of f ice and has a legal r ight t o be able t o exchange t he pr emium bond in r et ur n f or cash.
Not e her e t he specif ic use of t he wor d “sur r ender ”. This is ver y dif f er ent t o t he wor d “sale”. For example, if an employee wer e given a yacht as a bonus by his employer , t his would not const it ut e ear nings f or NI C pur poses as he could not t ake t he yacht back t o t he shop and demand cash f rom t he shop owner. This is not an asset t hat can be “sur r ender ed” f or cash in t he same way as a pr emium bond.
378 Principles of Business Taxat ion ‘Finance Act 2006’
Payment s in t he f or m of “readily convertible assets” ar e ear nings f or NI C pur poses. You will r ecall f r om t he PAYE chapt er , t hat a r eadily conver t ible asset is an asset t hat is t r aded on a r ecognised St ock or Commodit ies Exchange or an asset f or which t r ading ar r angement s exist . The def init ion of a r eadily conver t ible s. 702 asset f or NI C is exact ly t he same as t he def inition we looked at f or PAYE. The I TEPA 2003 r eadily conver t ible asset s legislat ion was put in r elat ively r ecent ly as many employer s had int r oduced imaginat ive NI C avoidance schemes t o r educe t heir NI C liabilit ies.
I f an employer settles an employee’s personal liability, t his payment will also const it ut e ear nings f or Nat ional I nsur ance. For example, if an employee makes a visit t o t he super mar ket and spends £ 100 on goods, and t hat £ 100 is subsequent ly r eimbur sed by t he employer , t he employer has paid f or an employee’s per sonal bill, and t hat payment will const it ut e ear nings f or NI C. As such, t he £ 100 will be char ged t o Nat ional I nsur ance.
Vouchers are ear nings f or NI C. Most commonly t hese will include High St reet st or e voucher s. Childcar e voucher s given t o employees ar e specif ically excluded and ar e not ear nings f or NI C.
Finally, certain share option rewards will const it ut e ear nings f or NI C.
The vast maj or it y of common benef it s will not be ear nings f or NI C pur poses. For inst ance, if an employee is given use of a company car or has a t axable cheap loan, t hat benef it will be char ged t o income t ax but it will not t hen be char ged t o Nat ional I nsur ance Cont r ibut ions in t he hands of t he employee.
D11.4 Class 1 Primary contributions s. 5
Primar y cont r ibut ions ar e paid by employees on ear nings in an “ear nings per iod”. Most UK employees have a mont hly ear nings per iod – i.e. we r eceive our salar y et c s.6 on a mont hly basis. Some employees, t ypically in manuf act ur ing indust r ies, st ill r eceive t heir ear nings weekly.
The cur r ent r at es of Nat ional I nsur ance ar e given in t he t ax t ables. For employees who r eceive t heir r emuner at ion weekly, no National Insurance is charged on the first £97 per week of an employee’s ear nings. This is called t he “ear nings t hr eshold” (ET). On earnings between £97 per week and £645 per week, t he main r at e of Class 1 NI C is 11%. The weekly limit of £ 645 is called t he “upper ear nings limit ” (UEL).
Employees also pay Class 1 NI Cs at t he addit ional r at e of 1% on earnings in excess of the upper earnings limit i.e. above £645 per week.
Class 1 Nat ional I nsur ance Cont r ibut ions 379
The t ables also give us t he annual limit s. Most employees have a mont hly ear nings per iod, so t o conver t t he annual limit s int o mont hly limit s, we simply divide by 12. For employees wit h a monthly earnings period, f or ear nings up t o £ 420 per s.8 month, NI C is charged at zero percent. For earnings between £420 and £2,795 per mont h, t he r at e is 11% and t her e is a f ur t her NI C liabilit y of 1% on ear nings in excess of £ 2,795 per mont h.
The mont hly and weekly limit s have been specif ically chosen t o equat e t o an ear nings t hr eshold of £ 5,035 per annum, which coincides wit h t he per sonal allowance. This is illustr at ed by t he diagr am below:
Nil 11% 1%
£0 £97 pw £ 645 pw £ 420 pm £ 2,795 pm £ 5,035 pa £ 33,540 pa
An employee will st ar t t o pay Class 1 primar y cont r ibut ions wit h ef f ect f r om his 16t h bir t hday and will st op paying NI C at t he dat e of r et ir ement , which f or a man is cur r ent ly 65 and, f or a woman, is 60.
NI Cs ar e calculat ed f or ear nings per iods. An employee who is paid mont hly will have 12 ear nings per iods in any par t icular t ax year , so t o calculat e his NI C f or t he year , we do 12 separ at e NI C calculat ions and add t hem t oget her .
Illustration 1
An employee has a salar y of £ 18,000 per annum which is paid mont hly. The employee has use of a company car giving rise to a benefit of £2,500. The employee get s a cash bonus at Chr ist mas of £ 5,000.
The salar y and t he Chr ist mas bonus const it ut e ear nings f or Class 1 NI C but t he company car benef it does not .
The mont hly limit s ar e:
Earnings threshold: £5,035 / 12 = £420
Upper earnings limit: £33,540 / 12 = £2,795
For 11 mont hs of t he year his ear nings will be 18,000/ 12 = £ 1,500. I n December his ear nings will be 1,500 + 5,000 = £ 6,500.
380 Principles of Business Taxat ion ‘Finance Act 2006’
The calculat ion will t her ef or e be as f ollows:
£ Class 1 pr imar y NI C 11 mont hs wit h ear nings of £ 1,500 £(1,500 – 420) x 11% x 11 months 1,307
1 mont h wit h ear nings of £ 6,500 £(2,795 – 420) x 11% x 1 month 261 £(6,500 – 2,795) x 1% x 1 month 37 NI C payable £1,605
The ef f ect of this is that part of the £ 5,000 bonus paid in December 2006, will only have been char ged t o NI C at 1%.
D11.5 Directors
The above r ules do not apply t o dir ect or s. All directors have an annual earnings period. This means t o calculat e a dir ect or ’s NI C we look at t heir ear nings in t he whole of t he t ax year , ir r espect ive of whet her t he dir ect or was paid on a weekly or monthly basis. This is to prevent a company director f rom manipulating the NI C r ules by paying himself in such a way as t o minimise his NI C f or t he year .
Illustration 2
Let us t ake t he f igur es in t he pr evious illustration but this time assume t hat t he salar y, t he car benef it and t he Chr ist mas bonus ar e accr uing t o a dir ect or r at her t han a nor mal employee.
To calculat e t he dir ect or ’s NI C we need t o aggr egat e his ear nings f or t he whole of t he t ax year and compar e t o t he annual limit s.
Annual ear nings £(18,000 + 5,000) = £23,000
Class 1 pr imar y NI C £(23,000 – 5,035) @ 11% £1,976
We see her e t hat , unlike as wit h t he employee in t he pr evious illust r at ion, none of t he dir ect or ’s ear nings will at t r act t he 1% r at e of NI Cs and f or t his r eason it t ends t o be mor e expensive f r om an NI C per spect ive t o be a direct or rat her t han a nor mal employee.
Class 1 Nat ional I nsur ance Cont r ibut ions 381
D11.6 Class 1 Secondary contributions
Class 1 secondar y cont r ibut ions ar e paid by employer s on any ear nings paid t o employees. The cur r ent r at e of Class 1 secondar y cont r ibut ions is zer o per cent on ear nings up t o t he ear nings t hr eshold and 12.8% on t he excess. The weekly, s.9 mont hly and annual ear nings t hr esholds are t he same f or employer s as t hey ar e f or employees.
Nil 12.8%
£ 0 £ 97 pw £ 420 pm £ 5,035 pa
You will also not e t wo t hings her e. The f ir st is t hat t he rate of NIC is higher for employers than for employees – i.e. 12.8% as opposed to 11%. The second t hing t o not e is t hat t her e is no upper earnings limit f or employer ’s cont r ibut ions, i.e. t he 1% r at e does not apply f or employer s. So f or ever y one pound of ear nings paid t o an employee above t he ear nings t hr eshold, t he employer will have t o pay 12.8 pence in Nat ional I nsur ance Cont r ibut ions.
This is a subst ant ial cost f or employer s t o have to bear and, effectively, adds near ly anot her 12.8% t o t heir t ot al wages bill.
I n t he case of an employee or dir ect or ear ning £ 23,000 per year , t he secondar y liabilit y t o be paid by t he employer is:
£ (23,000 – 5,035) @ 12.8% = £ 2,300
Employer secondar y cont r ibut ions begin wit h ef f ect f r om t he employee’s 16th birthday but there is no upper age limit. So if a salary is paid to an employee who is 68 year s old, t he employee will have no Class 1 pr imar y liabilit y but t he employer will st ill have t o pay Class 1 secondar y cont r ibut ions at 12.8%.
D11.7 State Second Pension
When we calculat ed t he employee’s Class 1 NI C liabilit y in t he pr evious illust r at ions, we did so on t he assumpt ion t hat t he employee had not “cont r act ed out ” of t he St at e Second Pension.
The St at e Second Pension pr ovides individuals wit h an Addit ional St at e Pension. The amount of t he pension r elat es t o t he ear nings of t he employee but is mor e gener ous f or t he low paid.
I t is possible f or an employee to contract out of the State Second Pension and if he does so, he is informing the Government that he will make his own pension ar r angement s. Ther e ar e cer t ain advant ages f r om an NI C point of view of cont r act ing out of t he St at e Second Pension.
382 Principles of Business Taxat ion ‘Finance Act 2006’
I f an employee cont r act s out of t he St at e Second Pension and inst ead has an occupat ional pension scheme wit h his employer , t hat employee will get a 1.6% r ebat e on his Nat ional I nsur ance Cont r ibut ions. This means t hat t he r at e of NI C he will pay f alls f r om 11% t o 9.4%.
I f an employee cont r act s out of t he Stat e Second Pension and has a per sonal pension, t he employee will cont inue t o pay NI C at t he normal rate of 11% but t he Nat ional I nsur ance Cont r ibut ions Of f ice will then take the rebated amount of 1.6% and redirect it into the employee’s personal pension scheme.
Wher e an employee has cont r act ed out of t he St at e Second Pension, employer ’s secondar y cont r ibut ions bet ween t he ear nings t hr eshold and t he upper ear nings limit will be 9.3% as opposed t o 12.8%.
D11.8 Overseas aspects
Per sons (individuals or companies) ar e not r equir ed t o pay Class 1 NI Cs unless t hey s. 1(6) ar e “r esident or pr esent ” in Great Br it ain.
Great Br it ain means England, Scot land and Wales (i.e. not Nor t her n I r eland) alt hough t he det ailed r egulat ions in SI 2001/ 1004 (par agr aph 145 onwar ds) do ext end t hese pr ovisions t o Nor t her n I r eland. For t he r est of t his session, we shall use t he t er m “UK”.
Class 1 pr imar y cont r ibut ions ar e payable by employees who ar e eit her - resident, or - present, or - ordinarily resident in t he UK.
Secondar y cont r ibut ions ar e payable by employer s who ar e r esident or pr esent in t he UK when cont r ibut ions become payable or who have a place of business in t he UK at t hat point .
“Residence” and “or dinar y r esidence” ar e not separ at ely def ined f or NI C and will t her ef or e t ake t he meaning as out lined in t he Revenue’s booklet I R20 (i.e. as f or income t ax). The t er m “pr esent ” is similar ly undef ined but has a looser int er pr et at ion t han f or mal “r esidence”. Any questions as to whether an employed ear ner is “pr esent ” in t he UK will be dealt wit h on a case by case basis.
For employees coming t o t he UK or leaving t he UK, t he Class 1 NI C posit ion can be complex and depends lar gely on whet her t he UK has a reciprocal social security agreement wit h t he ot her count r y.
As a gener al r ule, social secur it y agr eement s t r y t o ensur e t hat an employee pays “social secur it y” (i.e. NI C) only in t he count r y in which he is act ually employed. The UK has such r ecipr ocal agr eement s wit h EU count r ies and wit h ot her count r ies such as t he USA.
Class 1 Nat ional I nsur ance Cont r ibut ions 383
Problems only t her ef or e t end t o ar ise if an employee is going t o or coming f r om a “non r ecipr ocal” count r y.
(i) Leaving t he UK
I f an employee leaves t he UK t o t ake up employment abr oad, liabilit y t o pay Class 1 NI Cs can continue for a period of 52 weeks f r om t he dat e of depar t ur e. Class 1 secondar y liabilit ies will also cont inue.
This “52 week NIC extension” will only apply if SI 2001/ 1004 par a 146 - t he employer has a place of business in t he UK; and - t he employee is or dinar ily r esident in t he UK; and - immediat ely pr ior t o commencing employment abr oad t he employee was r esident in t he UK.
Ther ef or e t he 52 week NI C ext ension will t ypically apply t o employees wor king over seas f or shor t per iods. I f an employee leaves t he UK t o t ake up per manent employment abr oad, he would be t r eat ed as not ordinarily resident and liabilit y t o pay Class 1 NI C would cease at t he dat e t he UK employment ceased.
Any employee not paying Class 1 NI Cs is ent it led t o make voluntary Class 3 contributions in order to preserve entitlements to state benefits et c.
(ii) Coming t o t he UK SI 2001/ 1004 par a 145(2) Wher e an employed ear ner comes t o t he UK, one of t wo t hings will happen f or NI C pur poses:
1. I f t he employee comes t o t he UK f r om a count ry wit h which t he UK has a r ecipr ocal agr eement , Class 1 NI Cs (pr imar y and secondar y) will either commence from the date of arrival, or t he employee will continue to pay contributions in the home country. The t r eat ment depends on how long t he employee is st aying in t he UK and on t he t er ms of t he r ecipr ocal agr eement .
2. I f t he employee comes t o t he UK f r om a count ry wit h which t he UK has no r ecipr ocal agr eement , pr oviding t hat - t he employee is not or dinar ily r esident in t he UK; and - t he employment is mainly out side t he UK wit h an employer whose place of business is out side t he UK; no Class 1 NICs are payable for 52 weeks f ollowing t he employee’s ar r ival.
This “52 week NIC holiday” would most commonly apply t o employee’s wor king t empor ar ily in t he UK f or an over seas employer . Af t er 52 weeks, Class 1 pr imar y and secondar y cont r ibut ions will become payable in t he usual way.
384 Principles of Business Taxat ion ‘Finance Act 2006’
D11.9 NIC administration
NI Cs ar e dealt wit h on a day t o day basis by t he National Insurance Contributions Office (NICO).
The collect ion and payment of Class 1 NI Cs is t he r esponsibilit y of t he employer SI 2001/ under the PAYE regulations. I f an employer fails to comply with the regulations, 1004 Reg 67 not ices under Sch 4 SI 2001/ 1004 can be issued t o r ecover any NI Cs under paid. S.203
Class 1 NI Cs ar e due f or payment wit hin 14 days of t he end of t he income t ax Sch 4 Par a 10 mont h. Quarterly payments can be made if the income tax and NIC to be account ed f or is less than £1,500 per month on average.
I nt er est is char ged on Class 1 cont r ibut ions paid lat e. The r ules f or char ging Sch 4 int er est ar e gener ous in t hat int er est will only st ar t t o accr ue f r om t he “r eckonable Par a 17 dat e” which is 14 days af t er t he end of t he t ax year f or which t he NI Cs wer e due. Therefore for NI Cs paid late in 2006/07, interest will only start to run from 19 April 2007.
Det ails of Class 1 pr imar y and secondary NI Cs payable must be included on the employer’s end of year summary (form P35). Penalties for late or incorrect f or ms P35 ar e as f or income t ax (see Chapt er 22). Penalties cannot be charged twice for tax and NIC failures in respect of the same form(s).
Taxpayer s have a r ight of appeal against any assessment of nat ional insur ance cont r ibut ions, and t he appeals pr ocedur e is laid out in t he Social Securit y Act (SSA) 1998. The NI C appeals pr ocedur e f ollows t hat f or income t ax. Appeals ar e made in t he f ir st inst ance t o t he Of f icer of Revenue and Cust oms and, if no agr eement can be r eached, t he appeal will be list ed f or hear ing bef or e t he Gener al (or Special) Commissioner s. Appeals against a Commissioner s decision can only be made on a point of law and such appeals will t her eaf t er be r ef er r ed by a “case st at ed” t o t he High Cour t , Cour t of Appeal and f inally t he House of Lor ds.
The power s of Of f icer s t o enf or ce collect ion of NI Cs and t o obt ain inf or mat ion pur suant t o t he assessment and collect ion of NI Cs ar e cont ained at s.109A – s.109C Social Secur it y Administ r at ion Act (SSAA) 1992. These pr ovisions give Of f icers the right to - issue not ices t o any per son r esponsible f or t he payment of NI Cs (and cer t ain ot her per sons such as t r ader s, local aut hor it ies, agent s or t r ust ees), r equir ing t hat per son t o pr ovide inf or mat ion as specif ied in t he not ice which t he Of f icer may “r easonably r equir e”; and
Class 1 Nat ional I nsur ance Cont r ibut ions 385
- ent er any pr emises t o eit her examine t he pr emises or conduct any enquir y t her e as “appear s t o him appr opr iat e”. Such pr emises may include places of employment or ot her pr emises as list ed in s. 109C. The Of f icer must , if r equir ed, pr oduce a cer t if icat e of aut hor isat ion.
Wher e a per son f ails t o pr oduce inf or mat ion as specif ied in a not ice or “int ent ionally delays or obst r uct s an Of f icer in t he exer cise of any power ”, a penalt y will be char ged. This penalt y is up t o £ 1,000 plus up t o £ 40 per day t her eaf t er if t he f ailur e cont inues.
A f ine of up t o £ 5,000 (or up t o 3 mont hs impr isonment in ser ious cases) can be char ged on any per son who knowingly makes a f alse st at ement or knowingly pr oduces f alse document s, inf or mat ion or ot her mat er ial.
Penalt ies ar e also imposed by s. 113 and s. 114 SSAA 1992 f or breaches of NI r egulat ions or f r audulent evasion of NI Cs.
Example 1
Which of t he f ollowing f or ms of r emuner at ion ar e ear nings f or Class 1 NI C pur poses?
a) I nt er est f r ee loan b) £ 5,000 of pr emium bonds c) £ 20,000 of gold bullion d) J ohn Lewis st or e voucher e) Reimbur sement of home t elephone calls f) Reimbur sement of business expenses
Example 2
Har r y is an employee ear ning £ 26,000 per year . He is paid weekly and in Mar ch 2007 he r eceived a bonus of £ 1,000.
Calculat e his Class 1 NI C due f or 2006/ 07.
386 Principles of Business Taxat ion ‘Finance Act 2006’
Answer 1
Ear nings? a) I nt er est f r ee loan X (No NI Cs on benef it s) b) £ 5,000 of pr emium bonds (Sur r ender ed f or cash) c) £ 20,000 of gold bullion (Readily conver t ible asset ) d) J ohn Lewis st or e voucher e) Home t elephone bill (Set t lement of employee’s liabilit y) f) Reimbur sed business expenses X
Answer 2
Ear nings: 51 weeks @ £ 500 1 week @ £ 1,500
NI C: £ £ (500 – 97) @ 11% x 51 2,261 £ (645 – 97) @ 11% x 1 60 £ (1,500 – 645) @ 1% x 1 9 Tot al £2,330
Class 1 Nat ional I nsur ance Cont r ibut ions 387
SUMMARY - CLASS 1 NATIONAL INSURANCE
Class 1 cont r ibut ions ar e paid by bot h employees (pr imar y cont r ibut ions) and employer s (secondar y cont r ibut ions) on ear nings f r om employment .
Ear nings include: Cash payment s (ot her t han r eimbur sement of genuine business expenses) Payment s in kind t hat can be sur r ender ed f or cash Readily conver t ible asset s Set t lement of employee’s per sonal liabilit y Voucher s (except childcar e) Cer t ain shar e opt ion r ewar ds
The calculat ion of Class 1 pr imar y cont r ibut ions is done f or an ear nings per iod f or employees. The weekly limit s ar e:
First £ 97 no NI C £ 97 - £ 645 11% Above £ 645 1%
Mont hly limit s are obt ained by mult iplying by dividing t he annual limit s by 12.
The cont r ibut ions st ar t at age 16 and st op at r et ir ement age (65 f or men, 60 f or women).
For a dir ect or an annual ear nings per iod must be used.
Class 1 secondar y cont r ibut ions ar e at 12.8% on t he excess above t he ear nings t hr eshold.
The cont r ibut ions st ar t at 16 but t her e is no upper age limit .
I f t he employee cont r act s out of t he Second St at e Pension, a lower r at e of NI C will be payable.
Class 1 NI C is only payable in r espect of employees who ar e r esident , pr esent or or dinar ily r esident in t he UK.
For employees coming t o or leaving t he UK, t he Class 1 NI C posit ion will be gover ned by a r ecipr ocal social secur it y agr eement if t he UK has one with the other country. I f t her e is no r ecipr ocal agr eement t her e may be a 52 week NI C ext ension f or leaver s and a 52 week NI C holiday f or ar r iver s depending on t he cir cumst ances.
NI CO is part of HM Revenue and Customs and is r esponsible f or t he administ r at ion of NI C. The due dat es, int er est and penalt y posit ion essentially mir r or s t hat f or PAYE.
D12: CLASS 1A AND 1B NATIONAL INSURANCE CONTRIBUTIONS
I n t his chapt er you will cover t he t wo f ur ther classes of NI C payable by employer s including: - Class 1A NI C; - Class 1B NI C; - PAYE set t lement agr eement s.
All r ef er ences in t his chapt er ar e t o SSCBA 1992 unless ot her wise st at ed.
D12.1 Introduction
Class 1A NI C is paid by employers only. Employees do not pay Class 1A Nat ional s. 10 I nsur ance.
Class 1A NI C is paid by employer s on t he cash equivalent of benefits as t hey appear on t he f or m P11D. As Class 1A NI C is t he liabilit y of t he employer , it is char ged at t he employer ’s r at e of 12.8%. Payment is made in one sum on 19 J uly f ollowing t he end of t he t ax year . This is deliber at ely t imed so as t o be t wo weeks af t er t he submission of t he f or m P11D t o t he Revenue. So having ar r ived at t he cash equivalent of t he benef it , it is easy f or t he employer t o t hen go ahead and calculat e his Class 1A NI C liabilit y.
Class 1B is also paid by employers only. Class 1B NI C is charged on ear nings which ar e included wit hin a Pay As You Ear n Set t lement Agr eement (PSA). We will look s. 10A at PSAs lat er in t his session. The rat e of NI C is 12.8%. Class 1B NI C is collect ed annually on 19 Oct ober f ollowing t he end of t he t ax year .
D12.2 Class 1A
Ther e is no Class 1A char ge if t her e is no associat ed income t ax liabilit y. This means t hat exempt benef it s such as a mobile phone, a wor k car par king space, or exclusive nur ser y et c, will not be char ged t o Class 1A NI C. The £ 50 exempt ion f or ot her t ypes of childcar e applicable t o income t ax also applies t o Class 1A NI Cs.
Similarly, if benefits ar e pr ovided to lower paid employees – i.e. employees ear ning less t han £ 8,500 per annum – no P11D will be pr epar ed by t he employer so accor dingly t her e is no liability to Class 1A Nat ional I nsur ance Cont r ibut ions.
I f a payment in kind is categorised as ear nings, and as such is char ged t o NI C under t he nor mal Class 1 r ules, t hat benef it will not be char ged on t he employer under Class 1A.
Class 1A and 1B Nat ional I nsur ance Cont r ibut ions 389
Ther ef or e if an employer pr ovides an employee wit h benef it s such as pr emium bonds or r eadily conver t ible asset s or High St r eet st or e voucher s, t he employer will have t o pay Class 1 secondar y cont r ibut ions on t hose benef it s because t hey ar e classif ied as ear nings. The employer will not have t o pay Class 1A as well.
As we shall see lat er , if a benef it is char ged t o Nat ional I nsur ance under Class 1B, t his also t akes pr ior it y over Class 1A.
Finally, if an employer r eimbur ses genuine business expenses t o an employee, as t his is not a t axable benef it , it will not give r ise t o a Class 1A NI C char ge.
Illustration 1
An employee r eceives t he f ollowing r emuner at ion package f or 2006/ 07:
£ Salary (paid mont hly) 24,000 Company car benef it 4,200 Medical insur ance benef it 600 High st r eet st or e voucher (awar ded December 2006) 200 Cash bonus (Mar ch 2007) 10,000
To calculat e t ot al Nat ional I nsur ance Cont r ibut ions payable f or t he t ax year , we f ir st calculat e t he Class 1 pr imar y cont r ibut ions payable by t he employee on his earnings. We t hen move on t o calculate t he Class 1 secondar y cont r ibut ions paid by t he employer on ear nings given t o t he employee. The f inal Nat ional I nsur ance will be t he Class 1A NI C’s payable by t he employer on t he benef it s awar ded t o t he employee.
We st ar t wit h t he Class 1 pr imar y cont r ibut ions. The employee is paid mont hly so he has a mont hly ear nings per iod. For 10 mont hs of t he year he ear ns a salar y of £ 2,000.
I n December 2006, he is given a High St r eet st or e voucher . This is r egar ded as ear nings f or Class 1 NI C pur poses so his ear nings f or December 2006 go up t o £ 2,200. Due t o t he cash bonus of £ 10,000 paid in March 2007, f or t his mont h his ear nings in t he per iod go up t o £ 12,000.
Ear nings: 10 mont hs @ £ 2,000 1 mont h @ £ 2,200 1 mont h @ £ 12,000
Employees pay Class 1 Nat ional I nsur ance Cont r ibut ions at 11% on mont hly ear nings bet ween t he ear nings limit s and at 1% above t he upper ear nings t hr eshold. The mont hly ear nings t hreshold f or 2006/ 2007 is £ 420 and t he mont hly upper ear nings limit is £ 2,795.
390 Principles of Business Taxat ion ‘Finance Act 2006’
£ Class 1 pr imar y £(2,000 – 420) @ 11% x 10 months 1,738 £(2,200 – 420) @ 11% x 1 month 196 £(2,795 – 420) @ 11% x 1 month 261 £(12,000 – 2,795) @ 1% x 1 month 92 £2,287
Next we move on t o Class 1 secondar y contr ibut ions. Tot al ear nings f or t he year ar e t he salar y of £ 24,000, t he st or e voucher s of £ 200 and t he bonus of £ 10,000. Tot al ear nings, subj ect t o secondar y cont r ibut ions in t he year , ar e t her ef or e £ 34,200. As t her e is no upper ear nings limit f or secondar y cont r ibut ions, all ear nings in excess of t he ear nings t hr eshold will be charged t o NI C at t he r at e of 12.8%.
Class 1 secondar y £(34,200 – 5,035) @ 12.8% £3,733
Finally, we calculat e t he Class 1A liabilit y. The car benef it is £ 4,200. The only ot her benef it which will appear on t he P11D f or t he year is t he medical insur ance of £600. We add this on to give us t ot al t axable benef it s f or t he year of £ 4,800.
Class 1A £4,800 @ 12.8% £614
I n summar y t he f ollowing NI Cs ar e due:
Class 1 primary £2,287 Collect ed mont hly via PAYE syst em
Class 1 secondary £3,733 Collect ed mont hly via PAYE syst em
Class 1A £614 Paid direct ly t o NI CO on 19 July 2007
This example demonst r at es t he int er act ion bet ween Class 1 pr imar y and secondar y cont r ibut ions and Class 1A NI C. What it also shows is t hat t he NI C bur den is much heavier on employer s t han on employees. This is part ly because t her e is no upper ear nings limit f or employer s and also because employees do not have t he bur den of Class 1A cont r ibut ions.
D12.3 Class 1B contributions
To under st and Class 1B cont r ibut ions we f ir st need t o discuss exact ly what we mean by t he t er m Pay As You Earn Settlement Agreement (PSA). For t hose of you who have access t o t he t ax st at ut es, it is cert ainly wort h t aking a look at s.703 St at ement of Pract ice Number 5 of 1996 (SP 5/ 96) in which t he I nland Revenue I TEPA 2003 ver y clear ly set out what can and what cannot be included wit hin a PAYE Set t lement Agr eement .
Class 1A and 1B Nat ional I nsur ance Cont r ibut ions 391
The whole idea of a PSA is t o allow an employer to settle an employee’s tax liability on minor or irregular benefits. A common example of an ir r egular benef it which could be encompassed wit hin a PSA, would be a st af f Chr ist mas par t y cost ing in excess of t he t ax-f ree t hr eshold of £ 150 per per son.
I f an employer pr ovides a Chr ist mas par t y t o an employee, and t he cost of t he part y is less t han £ 150 per employee, t his is an exempt benef it . However, if t he cost exceeds £ 150, t he employee has a t axable benef it on t he whole cost . I t is t her ef or e cust omar y, as a gest ur e of goodwill, f or t he employer t o meet any t ax liabilit ies ar ising t o employees. The employer will do t his by negot iat ing a t ax set t lement wit h t he Revenue.
The Revenue has also conf ir med t hat PSAs ar e accept able in inst ances wher e it is impractical for the employer to be able to apply Pay As You Earn to a par t icular emolument .
SP 5/ 96 clear ly st at es t hat Pay As You Ear n Set t lement Agr eement s should not be used as a vehicle f or set t ling t ax liabilit ies on cash payment s or on maj or benef it s such as company car s or low int er est loans et c.
I f t ax on a par t icular benef it is included wit hin a PSA, t hat benef it does not t hen have t o be ent er ed on t o f or m P11D. Similar ly, t he employee will not have t o ent er t he cash equivalent of such benef it s on t o his own Self Assessment Tax Ret ur n. This is because someone else – ie, t he employer - will pay t he t ax.
Having agr eed t hat it ems can be included wit hin t he PSA, t he Revenue will t hen negot iat e t he t ax liabilit y wit h t he employer and t he employer will pay t he t ax on a gr ossed up basis.
Illustration 2
A company has 100 employees. I t holds a Summer Ball and t he t ot al cost of t hat f unct ion is £ 20,000, ie exact ly £ 200 per head. Technically each employee will t her ef or e have a benef it of £ 200 as t he cost of t he par t y exceeds t he £ 150 per head t hr eshold. However , as a gest ur e of goodwill, t he company agr ees t o meet t he t ax liabilit ies via a Pay As You Ear n Set t lement Agr eement . Of t he employees, 50 of t hem pay t ax at t he basic rate of 22%, whilst 50 of them pay t ax at t he higher rat e of 40%.
I n or der t o wor k out t he amount of t ax t o be paid by t he employer under t he PSA, consider t he basic r at e employees f ir st . Each employee will have a benef it of £ 200. This is a “net ” benef it because t he employee is deemed t o have r eceived a benef it of £ 200 after t he t ax has been set t led by t he employer .
To calculat e t he t ax on t his net benef it , as we ar e dealing wit h a basic r at e employee, we need t o mult iply t he net f igure of £ 200 by 22 over 78. This gives us t ax of £ 56 and gives r ise t o a gr oss benef it of £ 256. I f you work t his back, you will see t hat t he gr oss benef it of £ 256 mult iplied by t he basic rat e of t ax of 22% gives a t ax char ge of £ 56.
392 Principles of Business Taxat ion ‘Finance Act 2006’
Basic r at e employee: £ Net benefit 200 22 56 Tax @ 78 Gross benef it £256
For each higher r at e employee, again we start with the net benef it of £ 200. This t ime we ar r ive at t he t ax by multiplying t he net benef it by 40/ 60 t o give t ax of £ 133. The gr oss benef it in t his inst ance is £ 333. Again we can check t his by t aking t he gr oss benef it of £ 333 and mult iplying it by t he higher rat e of 40% t o give t ax of £ 133.
Higher r at e employee: £ Net benefit 200 40 133 Tax @ 60 Gross benef it £333
To f inish t he example, we need t o calculat e t he t ot al t ax t o be included in t he PSA:
Tax in PSA £ 50 employees @ £ 56 2,800 50 employees @ £ 133 6,650 £9,450
Whenever t ax is set t led under a PAYE set t lement agr eement , t he employer also needs t o consider t he impact of Class 1B Nat ional I nsur ance. Class 1B NI C is char ged on benef it s included wit hin a PSA. I ncluded wit hin t he PSA is t he t ot al cost of t he st af f f unct ion - i.e. £ 20,000. We t hen need t o add on any income t ax t hat has been included wit hin t he PSA – i.e. any income t ax paid by t he employer on behalf of it s employees. Class 1B Nat ional I nsur ance is char ged at t he employer ’s r at e of 12.8%.
£ Ear nings wit hin PSA 20,000 I ncome t ax payable 9,450 29,450
Class 1B NI C @ 12.8% £3,770
Class 1B is t he employer’s liability only and t he due date for payment is 19 October following the end of the tax year.
Class 1A and 1B Nat ional I nsur ance Cont r ibut ions 393
At f ir st sight t his may appear a lit t le harsh, in t hat as well as paying income t ax of £ 9,450, t he employer also has t o pay Nat ional I nsur ance at 12.8% on t he income t ax paid. This is because t he income t ax of £ 9,450 is strictly the liabilit y of t he employees, so what t he employer is doing is set t ling t he employees’ per sonal liabilit y. We know t hat if an employer set t les an employee’s liabilit y under nor mal cir cumst ances, t her e will be a char ge t o Class 1 secondar y cont r ibut ions. Her e t he char ge is under Class 1B inst ead.
Example 1
Nor man r eceives t he f ollowing non-cash benef it s f r om his employer , Techno plc. Techno plc is a company list ed on t he UK st ock exchange.
a) Company car and f uel b) I nt er est f r ee loan of £ 4,000 c) 500 shar es in Techno plc d) £ 100 high st r eet st or e voucher e) Cont r ibut ions t o company pension scheme f) Member ship of local gym.
Which of t he above ar e subj ect t o Class 1A NI C?
Example 2
Br ian is awar ded a holiday t o Flor ida by his employer . The holiday cost £ 3,000 and t he company agr ee t o pay t he t ax on Br ian’s behalf via a PSA. Br ian is a salesman ear ning £20,000 per annum.
Calculat e t he Class 1B NI C liabilit y f or t he employer.
394 Principles of Business Taxat ion ‘Finance Act 2006’
Answer 1
Class 1A? a) Company car and f uel P11D it em b) I nt er est f r ee loan of £ 4,000 X Exempt as <£5,000 c) 500 shar es in Techno plc X Class 1 applies d) High st r eet st or e voucher X Class 1 applies e) Pension cont r ibut ions X Exempt f) Local gym member ship P11D it em
Answer 2
£ Ear nings cover ed by PSA 3,000 22 846 Tax @ (basic r at e t axpayer ) 78 £ 3,846
Class 1B NI C @ 12.8% £492
Class 1A and 1B Nat ional I nsur ance Cont r ibut ions 395
SUMMARY - CLASS 1A AND 1B NATIONAL INSURANCE
Class 1A is paid by employers on benef its that are on the P11D. The rate is 12.8% and t he due dat e is 19 J uly f ollowing t he t ax year .
Class 1A is not paid on benef it s which have alr eady been char ged t o Class 1 secondar y NI C. Also Class 1B t akes pr ior it y over Class 1A.
Class 1B is payable on benef it s included in and t ax set t led under a PAYE set t lement agr eement (PSA). The r at e is 12.8% and t he due dat e is 19 Oct ober f ollowing t he t ax year .
PSAs ar e used by employer s t o set t le t he t ax on minor or ir r egular benef it s or wher e it would be impr act ical t o apply PAYE. A gr ossing up exer cise must be done t o f ind t he t ax payable.
D13: TERMINATION PAYMENTS
I n t his chapt er you will cover t he way in which t er minat ion payment s ar e t axed including: - f ully t axable payment s; - f ully exempt payment s; - par t ially t axable payment s; - f or eign ser vice; - st at ut or y r edundancy pay; - employees appr oaching r et ir ement age; - payment s in lieu of not ice; - NI C implicat ions.
St at ut or y r ef er ences ar e t o I TEPA 2003 unless st at ed ot her wise.
D13.1 Introduction
Typical t er minat ion payment s will include compensation for loss of office, s.401- payment s, f or dismissal, – redundancy damages payments in lieu of notice s.416 “PI LONs” – and cer t ain payment s made on r et ir ement .
Ter minat ion payment s will eit her be f ully t axable, part ially t axable, or f ully exempt depending on t he nat ur e of t he payment .
The st at ut or y r ules concer ning t er minat ion payment s ar e cont ained at Sect ions 401 onwar ds I TEPA 2003. To under st and t he t axat ion of t er minat ion payment s we must f ir st r emind our selves of a couple of basic pr inciples.
I TEPA 2003 dif f er ent iat es bet ween “gener al ear nings” and “specif ic employment income”. “Gener al ear nings” ar e def ined in s.7(3) as earnings and any amount treated as earnings (such as benef it s under t he benef it s code). “Ear nings” ar e br oadly def ined in s.62 I TEPA 2003 as salar ies, wages and benef it s (in money or money’s wor t h), or anyt hing else t hat const it ut es an emolument of t he employment .
I n a number of decided t ax cases it has been held t hat emolument s ar e “of t he employment ” if t hey ar e given t o t he employee in return for services per f or med under t he employment cont r act . Ther ef or e, in general t erms, payment s made by an employer t o an employee which ar e not in r et ur n f or ser vices per f or med, will not be classed as “general earnings” under I TEPA 2003.
This gener al pr inciple is impor t ant as f ar as t er minat ion payment s ar e concer ned, because a t er minat ion payment will gener ally compensat e t he employee f or loss of of f ice r at her t han being any sor t of r ewar d f or ser vices per f or med.
Terminat ion Payment s 397
As such, most termination payments are not regarded as earnings f r om an employment and ar e t her ef or e taxed in a completely different way t o ot her ear nings such as salar ies and bonuses.
I nst ead, t er minat ion payment s will gener ally f all int o t he cat egory of “specif ic employment income” and will be t axed under t he pr ovisions of s.401 onwar ds I TEPA 2003.
D13.2 Does Section 401 apply?
This is an impor t ant quest ion because t her e ar e cer t ain exemptions and reliefs available wit hin t he legislat ion dealing wit h t er minat ion payment s which would not apply if t he payment wer e t o be t r eat ed as “gener al ear nings” under s.62.
Your st ar t ing point should be t o ask yourself whether the termination payment is contractual. I f t he employment cont r act cont ains a clause under which t he employee has a legal r ight t o r eceive a t er minat ion payment , t he t er minat ion payment will be r egar ded as ear nings f r om t he employment and will be t axed in f ull.
When t her e is any doubt about t he t axat ion of a t er minat ion payment , t he Revenue will ask t o see t he employment cont r act t o see if any r ef er ence is made t o t er minat ion payment s. I f t her e is, t he payment will be r egar ded as being made in r et ur n f or ser vices and will be f ully charged t o t ax.
I f t he cont r act is silent and makes no ment ion of t er minat ion payment s, if t he Revenue can pr ove t hat t her e was “reasonable expectation” on t he par t of t he employee t hat he would r eceive a t er minat ion payment , t he payment will be t axed in f ull. I t can be dif f icult f or t he Revenue t o pr ove t hat an employee expect ed t o r eceive a t er minat ion payment . The Revenue Of f icer will look back at past pr act ice and pr evious policy of t he employer t o see if ot her employees in a similar posit ion r eceived t er minat ion payment s.
I f a termination payment is made outside the employment contract and is t ot ally volunt ar y – ie, t he employee had no expect at ion what soever t hat he was t o r eceive such a payment – t his does not mean t hat t he payment is tax free. I t simply means t hat t he payment will be taxed under Section 401 which is t he sect ion t hat specif ically deals wit h t he t axat ion of genuine t er minat ion payment s.
S.401(3) says t hat “t his chapt er does not apply t o any payment or ot her benef it char geable t o income t ax apar t f r om t his chapt er ”. This means t hat if a payment is char ged t o t ax somewhere else in t he legislat ion, Sect ion 401 will not apply. For example, if a payment is t r eat ed as gener al ear nings f r om t he employment it will be t axed as ear nings under t he def init ion in Sect ion 62 which will t ake pr ior it y over Sect ion 401.
398 Principles of Business Taxat ion ‘Finance Act 2006’
This means t hat Sect ion 401 only applies t o non-cont ract ual or “ex gratia” payment s. Ex gr at ia her e lit er ally means “t hank you” – ie, t he payment is ent ir ely voluntary and without any obligation on t he par t of t he employer .
D13.3 Fully exempt payments
Cer t ain payment s f alling wit hin Sect ion 401 ar e f ully exempt f r om t ax.
A termination payment made on the death of an employee is f ully exempt f r om t ax. Similar ly, wher e t he employment has been t er minat ed due t o t he s.406 injury or disability of t he employee, any subsequent compensat ion payment is exempt f r om t ax.
I f an employer makes a payment to a tax-exempt pension scheme or appr oved per sonal pension ar r angement s as par t of t he t er minat ion package, t his is also completely free of tax. Making a t er minat ion payment t o such pension s. 408 schemes, r at her t han t o t he employee dir ect ly, is ver y ef f ect ive t ax planning and is commonly used in pr act ice.
Finally f ull exempt ion f r om t ax is given in inst ances wher e t he employee has a s.413 subst ant ial amount of f or eign ser vice. We shall look at foreign service s.414 exempt ions lat er on in t his chapt er .
D13.4 Partially taxable payments
The most impor t ant r ule as f ar as t er minat ion payment s ar e concer ned is t he £ 30,000 rule. Sect ion 403(1) says t hat t er minat ion payment s ar e only char ged s. 403(1) t o t ax t o t he ext ent t hey exceed £ 30,000. This means t hat t he first £30,000 of a genuine termination payment is tax free.
The £ 30,000 exempt ion only applies t o payment s which ar e t axable under Section 401. This means that this tax free amount only applies to genuine ex gr at ia compensat ion payment s such as r edundancy or compensat ion f or loss of of f ice. I t does not apply wher e t he employee has a cont r act ual r ight t o r eceive t he t er minat ion payment .
I f mor e t han one t er minat ion payment is made t o t he same employee, t he £ 30,000 exempt ion applies t o t he aggr egat e of all payment s. I f t er minat ion s.404(4) payment s ar e st agger ed so t hat t he employee r eceives t hem in dif f er ent t ax year s, t he £ 30,000 exempt ion applies t o t he ear lier payment f ir st .
I f a t er minat ion payment exceeds £ 30,000 so t hat some of it will be char geable t o t ax, t hat excess must be t axed at sour ce under PAYE. I f t he t er minat ion payment is made before the employer issues the form P45, income t ax must be deduct ed f r om t he excess under PAYE using t he employee’s tax code.
I f , however , t he t er minat ion payment is made after the form P45 has been issued t o t he employee, t ax is deduct ed on t he excess over £ 30,000 at t he basic rate of 22% only.
Terminat ion Payment s 399
I f an employer is uncer t ain as t o whet her t he £ 30,000 exempt ion applies, he can apply to the Inland Revenue for clearance. I t is ext r emely impor t ant t hat t he employer oper at es PAYE cor r ect ly as it is t he employer , and not t he employee, who is pr imar ily r esponsible f or paying any t ax which has been under deduct ed.
D13.5 Foreign service s.413 & s.414
Exempt ion f r om t ax can apply t o t er minat ion payment s wher e t he employee has f or eign ser vice. Wher e an employee has wor ked over seas and t hat employee r eceives an “ex gr at ia” t er minat ion payment , one of t wo t hings will happen. The t er minat ion payment will eit her be f ully exempt f rom t ax, or it will be part ially exempt .
The full exemption r ules ar e quit e complex. I f foreign service is at least three quarters of total service, t he t er minat ion payment is completely tax free. Ther ef or e, if an employee has been in ser vice f or 10 year s, and has spent s.413(1) 8 of t hose 10 year s abr oad, f or eign ser vice compr ises mor e t han t hr ee-quar t er s of t ot al ser vice so t he t er minat ion payment is f ully exempt .
I f this rule is not satisfied we move down to test number 2. This says that if total service has exceeded 10 years and the last 10 years of the employee’s service has been spent abroad, t he whole of t he t er minat ion payment is exempt from tax.
If neither test 1 nor test 2 have been satisfied, we finally move on to test number 3. This says that if total service has exceeded 20 years, any t er minat ion payment is tax free if at least half of total service has been spent abroad, including 10 of the last 20 years. These t hr ee r ules ar e dif f icult to remember but t hey ar e list ed in S.413(1).
I f none of t he t hr ee t est s has been sat isf ied, t hen only t he f or eign ser vice part s.414 of t he t er minat ion payment will be exempt f r om t ax.
Illustration 1
William was made r edundant in Mar ch 2007 and he r eceived an ex gr at ia t er minat ion payment of £ 150,000. William had wor ked f or t he company f or t he last 30 year s as below: Year s March 1977 to March 1983 London 6 March 1983 to March 1999 Paris 16 March 1999 to March 2007 London 8 Tot al 30
I n or der t o wor k out how much of t he t er minat ion payment is char geable t o t ax, we need t o apply t he t hr ee f or eign ser vice t est s t o see whet her t he t er minat ion payment is f ully exempt .
400 Principles of Business Taxat ion ‘Finance Act 2006’
The f ir st t est is whet her f or eign ser vice exceeds t hr ee quar t er s of t ot al ser vice. Her e t he answer is quit e clear ly “no” because f or eign ser vice is 16 year s and t ot al ser vice is 30 year s.
The second t est says t hat t he payment will be f ully exempt if t ot al ser vice exceeded 10 year s and t he whole of t he last 10 year s was spent out side t he UK. Again, t his is quit e clear ly not t he case as t he last 8 year s of William’s ser vice was spent in London.
The t hir d t est only applies if t ot al ser vice exceeds 20 year s which is t he case her e. Ther e ar e t wo mor e condit ions t o sat isf y, t he f ir st being t hat f or eign ser vice must be at last 50% of t ot al ser vice. For eign ser vice her e is 16 year s and t ot al ser vice is 30 year s so t his 50% condit ion is sat isf ied. Finally her e, we need t o check whet her f or eign ser vice makes up 10 of t he last 20 years. I f you look back at t he last 20 year s of William’s ser vice, you will see t hat 8 year s have been spent in t he UK and 12 year s have been spent in Par is so t his condit ion is sat isf ied.
As all three conditions in test 3 have been satisfied, f or eign ser vice is “subst ant ial” which means t hat t he whole of t he t er minat ion payment of £ 150,000 is t ax f ree.
The impor t ant t hing her e is t he appr oach t o t he quest ion. I f you ar e asked t o deal with this in practice, then draw a time line breaking service up into UK and over seas ser vice, t hen apply each of t he 3 t est s in order. I f any of the 3 test s ar e sat isf ied, t he t er minat ion payment is fully exempt .
Illustration 2
I f we wer e t o change t he example of William ver y slight ly, it will give r ise t o a signif icant ly dif f er ent r esult. Assume William st ill has 30 year s of t ot al ser vice, but inst ead of or iginally going t o Par is in Mar ch 1983 let us now assume t hat he or iginally went in Mar ch 1985.
Year s
March 1977 to March 1985 London 8 March 1985 to March 1999 Paris 14 March 1999 to March 2007 London 8 Tot al 30
This will reduce his foreign service from 16 years down to 14 years. We now need t o apply t he 3 f or eign ser vice t est s again. The f ir st t wo t est s clear ly ar e st ill not sat isf ied. For eign ser vice is clear ly not mor e t han t hr ee quar t er s of t ot al ser vice, and William has not spent t he last 10 year s out side t he UK.
Terminat ion Payment s 401
So let us r econsider condit ion number 3. Tot al ser vice has exceeded 20 year s, however f or t est 3 t o be sat isf ied, at least 50% of t ot al ser vice must be f or eign service. This is not the case here because f or eign ser vice is 14 year s and t ot al ser vice is 30 year s. This is less t han 50%. As such, none of t he t hr ee t est s ar e sat isf ied which means t hat t he t er minat ion payment of £ 150,000 is not f ully exempt .
I f t he t er minat ion payment is not wholly exempt , it must be par t ly t axable. When dealing wit h an ex-gr at ia t er minat ion payment , t he f ir st £ 30,000 is always t ax f r ee. This leaves a char geable amount of £ 120,000. Because par t of William’s ser vice includes f or eign ser vice, we can t ake a f or eign ser vice s.414(3) deduct ion f or t he t ime spent abr oad.
£ Ter minat ion payment 150,000 Less: exempt ion (30,000) 120,000 Less: f or eign ser vice deduct ion: 14 (56,000) £ 120,000 x 30 Taxable £64,000
This is char geable t o t ax as specific employment income f or 2006/ 07.
D13.6 Statutory redundancy pay
Redundancy payment s f all int o t wo cat egor ies, being st at ut or y and non- st at ut or y. St at ut or y r edundancy is an amount which must be paid by the employer t o t he employee under employment law and will be a f ixed amount f or s. 309 each year of ser vice. Statutory redundancy pay is exempt from tax ir r espect ive of t he amount paid.
However , if an employee r eceives st at utor y r edundancy as par t of an over all t er minat ion package, t he amount of t he statutory redundancy pay uses up part of the £30,000 exemption. For example, assume an employee is made r edundant and r eceives st at ut or y r edundancy of £ 2,000 plus an ex gr at ia payment of £ 100,000. The st at ut or y r edundancy is exempt f r om t ax but inst ead of having an exempt ion of £ 30,000 t o set against t he ex-gr at ia awar d, t his exempt ion is r educed by £ 2,000 down t o £ 28,000.
The t ax t r eat ment of non-st at ut or y r edundancy is set out by t he Revenue in SP 1/94. Non-st at ut or y r edundancy is essent ially an ex gr at ia awar d and is SP1/ 94 t her ef or e t axed in t he nor mal way under Sect ion 401. This means t hat t he r edundancy pay is t axable but only t o t he ext ent t hat it exceeds £ 30,000.
402 Principles of Business Taxat ion ‘Finance Act 2006’
D13.7 Employees approaching retirement age
Ter minat ion payment s will t ypically be made t o employees who ar e at or approaching retirement age. If an employee is r et ir ing due t o inj ur y or
disabilit y and r eceives a t er minat ion payment , t hat payment is f ully exempt .
However , payments made to retiring employees under nor mal cir cumst ances s.394 ar e t axable. The t ax t r eat ment is dealt wit h under SP 13/ 91. & SP13/ 91
SP 13/ 91 t ells us t hat payment s made t o employees “on or in connect ion wit h r et ir ement ” ar e t axable in f ull. This means t hat t he £ 30,000 exempt ion will not be available. This will be t he case even wher e an employee r eceives a genuine ex gr at ia payment t hat is not wit hin his employment cont r act and is not expect ed.
This r ule only applies t o employees “on or in connection with retirement”. Ther e has been much speculation as to what the Revenue mean by t he t er m “on or in connect ion wit h r et ir ement ”. The Revenue have said t hat t hey will give no “hard and f ast ” r ules as t o whet her an employee is r et ir ing and t he St at ement of Pract ice makes no r ef er ence t o a specif ic r et ir ement age.
The Revenue has accept ed t hat a middle aged employee who moves on t o anot her f ull t ime employment is not r et ir ing. As such, if t hat middle aged employee r eceives a t er minat ion payment , t he f ir st £ 30,000 will be exempt because t he pr ovisions of SP 13/ 91 will not apply.
However , when a payment is made t o an older employee, who is not moving on t o f ull t ime employment , t hat employee will be t r eat ed as r et ir ing. The payment will t her ef or e be caught by t he St at ement of Pract ice, so t he £ 30,000 exempt ion will not be available and t he payment will be t axable in f ull.
As a r ule of t humb, if you ar e dealing wit h any sor t of t er minat ion payment being made t o an employee over t he age of , say, 45 year s, t he pr ovisions of St at ement of Pract ice 13/ 91 must be considered. Again, t he Revenue can be appr oached in advance f or clear ance as t o whet her t he £ 30,000 exempt ion applies or not .
D13.8 PILONS
Payments in lieu of notice (PILONs) have been the subject of much discussion over recent years. The Revenue’s position on PILONs is summar ised in t heir Tax Bullet ins Tax Bulletin number 24 issued in August 1996 and amplif ied in Tax Bulletin Nos. 24, 63 Number 63 issued in February 2003.
I f a payment in lieu of notice is referred to in the employment contract, t he Revenue will r egar d it as a r ewar d f or ser vices and will tax it in full without the £30,000 exemption. This pr inciple was est ablished in t he t ax case of EMI v Coldicot t. I n t his case, t he employment cont r act r eser ved a r ight f or t he employer t o make a PI LON on t he t er minat ion of t he employment and t his pr ovision was enough t o make t he payment f ully t axable.
Terminat ion Payment s 403
The Revenue has always r egar ded payment s t o employees on “gar den leave” as being t axable in f ull and t his was conf ir med in Tax Bullet in 24. Gar den leave cover s sit uat ions when t he employee is not r equir ed t o wor k dur ing his not ice period but is inst ead sent home “t o do t he gar den” whilst st ill being paid. These payment s ar e t axable in f ull.
However , wher e t he employer makes a PI LON without having any contractual right or obligation t o do so, t he payment is likely to be treated as damages f or br each of cont r act and is taxed under Section 401 in t he nor mal way.
I n Tax Bullet in Number 63, t he Revenue has said t hat even if t he employment cont r act is silent and makes no pr ovision (discr et ionar y or ot her wise) f or t he employer t o make a PI LON, a subsequent payment t o an employee in place of he/ she wor king dur ing t heir not ice per iod could st ill be held t o be t axable in f ull as an emolument of t he employment . For example, if t he making of a PI LON is an aut omat ic r esponse by t he employer t o a t er minat ion of t he employment , t he Revenue ar e likely t o r egar d t he payment as an “int egr al par t of t he employer - employee r elat ionship” and will ar gue t hat t he sour ce of t he PI LON is t he employment, t her eby making t he payment f ully t axable. I n t heir view, t he f act t hat t he cont r act may be silent on t he point is immat er ial.
This is an aggr essive view and in pr act ice t he f act s and cir cumst ances of each case should be r eviewed separ at ely on t heir mer it s.
I f an employer t er minat es an employment cont r act without r egar d t o any cont r act ual not ice per iod, he is t r eat ed as br eaching t he cont r act . I f in r et ur n f or t hat br each of cont r act , he makes a payment in lieu of not ice t o t he employee, t hat payment is t r eat ed as a non-cont r act ual payment of damages and is not t axed in f ull. I n t hese cir cumst ances, t he f irst £ 30,000 of t he PI LON will be f r ee of t ax.
The t axat ion of PI LONs is a ver y hazar dous ar ea f or employer s and if t hey have any doubt s t hey should seek clearance bef or e making any payment s t o t heir employees. I ndeed many employer s t ake t he ver y pr udent st ep of t axing t he whole of t he payment – i.e. ignor ing t he £ 30,000 exempt ion – and leave it t o t he employee t o ar gue wit h t he Tax Of f ice as t o whet her t he exempt ion applies.
D13.9 NIC implications
Class 1 Nat ional I nsur ance Cont r ibut ions ar e paid on ear nings f r om t he employment . As f ar as t er minat ion payment s ar e concer ned, t he Nat ional I nsur ance Cont r ibut ions Of f ice have said t hat wher e a t er minat ion payment is made t o an employee under a contractual obligation, this payment will be regarded as earnings for NIC.
However , wher e an ex gr at ia payment is made – i.e. wher e t her e is no contractual obligation – t he payment will not be regarded as earnings and will not t her ef or e be char ged t o NI C. Ther ef or e as a br oad r ule, wher e a t er minat ion payment is made such t hat t he £ 30,000 exempt ion r ule applies f or income t ax, t her e will be no Nat ional I nsur ance Cont r ibut ions due.
404 Principles of Business Taxat ion ‘Finance Act 2006’
The £ 30,000 rule it self does not apply t o NI C. NI C is an “all or not hing” charge – i.e. t he payment is eit her f ully char ged t o Nat ional I nsur ance or f ully exempt . Ther ef or e wher e a t er minat ion payment is t axed in f ull, NI C will be levied on t he f ull amount .
Class 1 NI C is levied on bot h employees and on employer s. Employees have an upper ear nings limit f or Class 1 pr imar y cont r ibut ions which is current ly £ 33,540 per annum. This means t hat if a t er minat ion payment is made t o an employee who ear ns above t his upper ear nings limit , if t he t er minat ion payment is char geable t o NI C, t her e will only be a 1% addit ional char ge on t he employee. However , secondar y NI Cs will be levied on employer s in f ull.
D13.10 Miscellaneous points
Many t er minat ion agr eement s of t en incor por at e some sor t of r est r ict ive covenant . A t ypical r est r ict ive covenant clause is wher e t he employee pr omises s.225 not t o wor k f or a compet it or f ir m f or a cer t ain per iod of t ime af t er t he t er minat ion of his own employment .
Any such r est r ict ive covenant payment s made t o t he employee ar e t axed in f ull and t her e is no £ 30,000 exempt ion. S.225 I TEPA 2003 specif ically deals with restrictive covenants.
A t er minat ion payment need not necessar ily be in cash. Fr om t ime t o t ime, asset s ar e t r ansf er r ed t o employees as par t of t he t er minat ion agr eement – t hese ar e most commonly company car s. Many employer s allow employees t o keep t heir company car as par t of t he t er minat ion package. For t ax pur poses we value t he company car at t he dat e of t he gif t and t o t r eat t his as a cash payment .
I t is possible f or t he ex-employee t o cont inue t o r eceive cer t ain benef it s f r om t he employment even af t er t he employment has t er minat ed. I f t his is t he case, t hese cont inuing benef it s ar e simply t axed in t he year of r eceipt and t he cash equivalent of t hose benef it s is r epor ted t o t he Revenue on f or m P11D.
Cer t ain minor benef it s ar e now excluded f r om t he s.401 char ge – t hey ar e list ed in t he legislat ion. These ar e most ly benef it s which would nor mally be t ax f r ee such as mobile phones, st af f cant een, de minimis comput er equipment et c.
The employer may have cer t ain obligat ions t o r epor t t er minat ion payment s. A one of f r epor t needs t o be f iled by t he employer no lat er t han 6 J uly f ollowing t he end of t he t ax year if t he t erminat ion package exceeds £ 30,000 and includes non-cash benef it s.
Finally if a t er minat ion payment is t axable under S.401 (ie, if it exceeds t he £ 30,000 t hreshold), it is t axed on t he “t op slice” of a taxpayer’s income. This means t hat it will be t axed after dividend income. You may t her ef or e need a 4th column in your t ax comput at ion.
Terminat ion Payment s 405
Example 1
Char les is made r edundant on 30 November 2006 and r eceives t he f ollowing:
£ Ex-gr at ia cash payment 50,000 Company car (MV) 8,000 St at ut or y r edundancy pay 5,000 Employer cont r ibut ion t o pension f und 17,000 Tot al package £ 80,000
Calculat e t he amount char geable t o t ax under s.401.
406 Principles of Business Taxat ion ‘Finance Act 2006’
Answer 1
£ Ex gr at ia payment 50,000 Car @ MV 8,000 St at ut or y r edundancy pay Exempt Pension cont r ibut ion Exempt 58,000 Less: exempt ion (net of st at ut or y r edundancy pay) £ (30,000 - 5,000) (25,000) Taxable 2006/ 07 £33,000
Terminat ion Payment s 407
SUMMARY - TERMINATION PAYMENTS
A t er minat ion payment is f ully t axable if it is: A r ewar d f or ser vices per f or med Cont r act ual Expect ed
A t er minat ion payment is f ully exempt if it is: On death/ injury/ disability A payment int o an appr oved pension scheme Wher e f or eign ser vice is subst ant ial
“Ex-gr at ia” t er minat ion payment s such as r edundancy or compensat ion f or loss of of f ice ar e only t axable t o t he ext ent t hey exceed £ 30,000.
PAYE will be deduct ed using t he t ax code if t he payment is bef or e t he P45, but PAYE at 22% only is deduct ed if t he payment is af t er t he P45.
The t hr ee subst ant ial f or eign ser vice t est s ar e given in s.413 I TEPA 2003. I f t he f or eign ser vice is subst ant ial t he whole payment is exempt . I f it is not subst ant ial t hen only t he pr opor t ion r elat ing t o f or eign ser vice is t ax f r ee.
St at ut or y r edundancy pay is t ax f r ee but uses up par t of t he £ 30,000 exempt ion.
Payment s made t o employees on or in connect ion wit h r et ir ement age ar e likely t o be t r eat ed as f ully t axable wit h no £ 30,000 exempt ion (SP 13/ 91).
Cont r act ual PI LONS and payment s f or gar den leave ar e f ully t axable. PI LONS made in r et ur n f or br eaching a cont r act will be t axable t o t he ext ent t hey exceed £ 30,000.
NI C only applies t o cont r act ual t er minat ion payment s.
D14a: OCCUPATIONAL PENSIONS & FURBS
I n t his chapt er you will cover pension schemes including: - ways of pr oviding f unds f or r et ir ement ; - what pension f unds ar e; - how t ax r elief on cont r ibut ions t o pension schemes ar e given; - t he annual allowance; - t he lif et ime allowance.
St at ut or y r ef er ences ar e t o Finance Act 2004 unless st at ed ot her wise.
D14a.1 Introduction
Ther e ar e a number of ways in which an individual can pr ovide f unds f or his or her r et ir ement . Most UK individuals, when t hey r et ir e, will be ent it led t o some sor t of State Pension. The basic St at e Pension is cur r ent ly available t o men over t he age of 65 and women over t he age of 60. The unif icat ion of pensions at aged 65 f or all t axpayer s will be phased in bet ween 2010 and 2020.
The St at e Pension is f unded f r om Nat ional I nsur ance Cont r ibut ions. NI Cs cur r ent ly being paid by employees and employer s ar e f unding t he benef it s f or s. 577 t hose over r et ir ement age. Taxpayer s who r eceive t he St at e Pension r eceive it I TEPA 2003 gr oss and t he income is t axable under I TEPA 2003. The St ate Pension will not be consider ed any f ur t her dur ing t his cour se.
I f an individual wishes t o put f unds aside t o dr aw on dur ing r et ir ement , he or she can do so via a company pension scheme. A company or occupat ional pension scheme is pr ovided by t he employer f or t he benef it of t he employees. I f t he occupat ional scheme is r egist er ed wit h t he Revenue t her e ar e t ax advant ages f or bot h employer and employee.
Anot her way of pr oviding a r et ir ement f und is via a per sonal pension scheme. Per sonal pensions ar e available t o all individuals in t he UK, be t hey employed or self -employed. Self -employed per sons cannot j oin an occupat ional pension scheme because t hey do not have an employer . As such, pr ovision f or t heir r et ir ement will be made via a per sonal pension scheme.
I n Apr il 2001, t he Gover nment int r oduced St akeholder pensions. St akeholder pensions ar e modif ied ver sions of per sonal pensions designed t o encour age all individuals, especially t hose wit h low incomes, t o save f or t heir r et ir ement .
I ndividuals who wished t o make per sonal pension cont r ibut ions bef or e J uly 1988, did so via a r et ir ement annuit y scheme. Ret ir ement annuit y schemes wer e r eplaced by per sonal pension schemes in J uly 1988, alt hough member s of “old” r et ir ement annuit y schemes could cont inue t o make cont r ibut ions up unt il 2006.
Occupat ional Pensions & Fur bs 409
D14a.2 Pension Simplification
Unt il 5 April 2006, t here were t heref or e 3 dif f er ent pension r egimes:
• Company/ Occupat ional schemes; • Per sonal pension schemes; • Ret ir ement annuit y schemes.
These schemes had dif f er ent r ules wit h r egar d t o cont r ibut ions t hat could be made and in r espect of benef it s t hat could be dr awn on r et ir ement .
The Gover nment br ought in legislat ion in Finance Act 2004 t o abolish the existing pension provision schemes and replace them with a single regime with effect from 6 April 2006. The old pension r egimes will not be consider ed any f ur t her and in t his chapt er we will concent r at e on t he pension r ules as t hey apply f or t he t ax year s 2006/ 07 onwar ds.
D14a.3 Pension Funds
Bef or e we get int o t he det ailed r ules r egar ding pension schemes, it is wor t h explaining what a pension fund actually is. A pension fund is essent ially a “money box” int o which a t axpayer makes cont r ibut ions which he or she can draw on during retirement. The t axpayer will make cont r ibut ions t o a pension company and t he pension f und manager , on behalf of t he company, will invest t hose cont r ibut ions, of t en on wor ld st ock mar ket s.
One of t he main advant ages of r egist er ed pension f unds is t hat any growth is completely tax-free. The pension f und will not pay any income t ax on any int er est or dividend income and it will not pay any CGT on any capit al gains.
Most pension f unds ar e what ar e known as “money pur chase” schemes. This means t hat t he money invest ed by t he t axpayer is used t o pur chase unit s in t he f und and t he value of t hose unit s is ent ir ely dependent on t he under lying invest ment s made by t he f und manager. I f t he f und does well, t he t axpayer may dr aw a ver y healt hy pension however , if t he f und per f or ms badly, t he amount of money left in the “box” to draw on during retirement may not be as high as the t axpayer had hoped.
On retirement, t he t axpayer is ent it led t o dr aw a lump sum f r om t he f und and this lump sum is completely free of tax. This pr ocess is known as “commut at ion” and t he maximum amount t hat a t axpayer can commut e by way of
a lump sum is nor mally The restricted to 25% of the value of the fund. remainder of t he f und will be used t o generate an annual income f or the s. 571 t axpayer dur ing his or her r et ir ement . This pension income is t axable in t he I TEPA 2003 year in which it is received.
These money pur chase schemes ar e also known as “defined contribution” schemes because t he amount that the taxpayer can pay into his pension fund is restricted.
410 Principles of Business Taxat ion ‘Finance Act 2006’
Contributions to pension funds after 5 April 2006 are restricted depending on the level of the taxpayer’s earnings. Taxpayer s wit h higher ear nings can make lar ger pension cont r ibut ions t han t axpayer s wit h lower ear nings. Ther e is no longer any age related restriction on t he level of an individual’s cont r ibut ions. The age r elat ed r est r ict ions wer e abolished wit h ef f ect f r om 6 April 2006.
D14a.4 Registered pension schemes
A pension scheme will need t o be registered with the Revenue in order to be s. 153 t ax-pr ivileged. Exist ing pension schemes t hat alr eady have Revenue appr oval will
be r egist er ed aut omat ically.
The scheme may be est ablished by an employer f or t he benef it of it s employees. s.154 Alt er nat ively, t he pension scheme may be est ablished by cert ain ot her
pr ovider s, such as insur ance companies and banks. ss. 186, 187
Registered pension schemes will not be liable to pay tax on income and gains.
D14a.5 Maximum contributions
The maximum cont r ibut ion a t axpayer can make t o a pension f und in any one t ax
year is 100% of his “relevant earnings” f or t hat year. s.190
Anybody can pay up to £3,600 per year int o a pension scheme regardless of the level of his or her earnings. This is t o encour age individuals on modest incomes t o make pr ovision f or t heir r et ir ement .
Cont r ibut ions ar e not per mit t ed by t axpayer s over t he age of 75, alt hough t axpayer s who have r eached 75 will pr obably be dr awing on t heir pension r at her t han making f ur t her cont r ibut ions int o it .
Cont r ibut ions can be made by t he scheme member , a t hir d par t y on t he member ’s behalf (such as a parent on behalf of a child) or by an employer or f or mer employer .
D14a.6 “Relevant Earnings” s.189(2)
“Relevant ear nings” ar e calculat ed as f ollows £ Employment income (including benef it s) X Tr ading income X Fur nished holiday let t ings X Pat ent income in r elat ion t o invent ions X Relevant ear nings X
Employment income will be regarded as ear nings f or pension pur poses. As well as s.189(2)(a) salar y, t his will also include t he cash equivalent of any benef it s.
Occupat ional Pensions & Fur bs 411
Wher e a t axpayer r eceives a t er minat ion payment and is t axed on t he excess over t he £ 30,000 limit , t his excess will not be r egar ded as ear nings f or pension pur poses. Prof it s on shar e opt ions or shar e incent ives ar e not r egar ded as r elevant ear nings.
The pr of it s of t he self -employed char geable as t r ading income ar e also ear nings f or pension pur poses. This includes income f r om pr of essions and vocat ions which is t axed as t r ading income. Prof it s f rom a UK f ur nished holiday let t ing ar e s. 325 r elevant ear nings. A pr oper t y is r egarded as a f urnished holiday let if t he I TTOI A 2005 pr oper t y is available f or let t ing f or 140 days in a year, is act ually let f or 70 days in t he year and is not in t he same occupat ion f or mor e t han 31 consecut ive days.
D14a.7 Employer contributions
I f an employer makes a contribution to an employee’s pension scheme, t his is a tax-free benefit. However , employer cont r ibut ions do need t o be consider ed f or t he pur poses of t he annual allowance. This is discussed below.
Employer cont r ibut ions t o a pension scheme on behalf of an employee will be deduct ible expenses f or t he pur poses of calculat ing t he t axable pr of it s f r om t he employer ’s business, as long as t he cont r ibut ions ar e “wholly and exclusively f or t he pur poses of t he t r ade”. Pension cont r ibut ions ar e deduct ible f or t he per iod in which t he payment s ar e act ually made.
D14a.8 Annual allowance
The annual allowance is t he amount by which pension savings in a r egist er ed pension s.228 scheme (t he “t ot al pension input ”) ar e allowed t o incr ease each year . “Pension input ”
br oadly means employee’s plus employer’s pension contributions in t he t ax year .
Pension input could be by cont r ibut ions t o a “money purchase” or “defined
contribution” scheme. Such a scheme is one wher e t her e is no guarantee of the
pension benefits available and t hese ar e t he most common t ype of scheme.
The annual allowance also applies t o incr eases in t he capit al value of benef it s in a
“defined benefits” scheme. An example of a def ined benef it s scheme is a “final s.229 salary” scheme provided by an employer. I n such schemes, t he benef it s an individual can dr aw on r et ir ement ar e linked t o his r emuner at ion in t he f inal year (or year s) of employment .
The annual allowance for 2006/07 is £215,000. Annual incr eases in t he capit al s.228 value of a pension over and above t his limit will be subj ect t o a t ax char ge. The annual allowance will r ise each year by amount s t o be st ipulat ed by t he Tr easur y, and will be £ 255,000 by 2010/ 20011.
Annual increases in excess of the annual allowable amount are subject to an s. 227 annual allowance charge of 40%. The char ge is payable by t he individual member and will have t o be declar ed on t he self -assessment r et ur n.
412 Principles of Business Taxat ion ‘Finance Act 2006’
D14a.9 Tax relief for contributions
We have seen t hat a pension f und is a ver y t ax ef f icient invest ment . Regist er ed pension f unds t hemselves ar e not char ged t o income t ax or capit al gains t ax and a member of a scheme can withdraw up to 25% of the value of the fund on r et ir ement complet ely t ax-f r ee. However , per haps t he main r eason t hat pension f unds ar e popular is t hat t axpayer s r eceive a measur e of tax relief every time they make a contribution t o a r egist er ed scheme.
Tax r elief is obt ained on pension cont r ibut ions in one of t hr ee ways:
1. By “Relief At Source” (RAS) 2. Under “net pay ar r angement s” 3. By gr oss payment
Relief at Sour ce (RAS) s.192
Under t he Relief at Sour ce (RAS) r ules, payments to a pension scheme are made net of 22% basic rate tax. This means t hat if a t axpayer want s £ 1,000 t o go int o his pension f und, he will act ually pay £ 780 and t he Revenue will make up t he dif f erence of £ 220.
I f t he t axpayer pays t ax at t he higher r at e of 40%, ext r a t ax r elief is given on t hese cont r ibut ions by extending the basic rate band. This is exact ly t he same as t he way in which t ax r elief is given on donat ions t o charit y under t he Gif t Aid scheme.
Ther ef or e wher e a pension cont r ibut ion is made, t he or iginal basic r at e t hr eshold of £ 33,300 is ext ended by t he gr oss amount of t he pension cont r ibut ion – i.e. t he net cont r ibut ion mult iplied by 100/ 78. This gives us a new basic r at e t hr eshold and we use t his new f igur e t o calculat e t he t axpayer ’s t ax liabilit y. 100 New basic r at e t hr eshold = £ 33,300 + pension cont r ibut ion x 78
I t is impor t ant t o not e t hat t he t axpayer ’s maximum contribution – i.e. the higher of 100% of relevant earnings or £3,600 – gives us the gross amount. So having calculat ed t he maximum cont r ibut ion in t his way, t he amount the taxpayer will physically pay is this figure multiplied by 78%.
Net pay ar r angement s s.193
Employees making cont r ibut ions t o an employer r un scheme can obt ain t ax r elief via a net pay ar r angement . When deduct ing t ax under PAYE, t he employer will operate PAYE on the employee’s “net pay” – i.e. gr oss pay less t he pension cont r ibut ion. Ther ef or e t he mor e an employee pays by way of a pension cont r ibut ion, t he less t ax will be deduct ed under PAYE.
Occupat ional Pensions & Fur bs 413
Pension cont r ibut ions do not r eceive r elief f r om nat ional insur ance cont r ibut ions so NI Cs ar e calculat ed on gr oss salar y.
When put t ing t oget her t he employee’s income t ax comput at ion, pension cont r ibut ions ar e given as a deduct ion f r om ear nings as below:
£ £ Salar y, bonus et c X Benef it s X Taxable ear nings X Less allowable deduct ions: Employment expenses X Pension contributions X (X) NET TAXABLE EARNI NGS X
Gross payment s.194
Wher e t he individual has been making cont r ibut ions t o an old retirement annuity policy, under t he new r egime t he insur ance company will cont inue t o collect cont r ibut ions on a gr oss basis. This means t hat no r elief will be obt ained at sour ce. I nst ead t ax relief will be given via the self assessment return and t he pension payment will simply be deducted f r om ear nings in t he income t ax comput at ion. For example:
Non Savings I nt er est Dividends
Employment income X Tr ading income X FHL pr of it X X Less: pension contributions (X) X Proper t y income X I nt er est X Dividends X For eign income X X X Total income T T T Less: Char ges on income (X) ______St at ut or y t ot al income STI STI STI
414 Principles of Business Taxat ion ‘Finance Act 2006’
D14a.10 Lifetime allowance
A lif et ime limit is placed on t he t ot al value of t he pension f und t hat can benef it s. 218 f rom t ax relief . This limit is called a lifetime allowance. The lif et ime allowance
has been set as £1.5m for 2006/2007. The lif et ime allowance will r ise as f ollows:
2007/ 2008 £ 1.6m 2008/ 2009 £ 1.65m
2009/ 2010 £ 1.75m 2010/ 2011 £ 1.8m
Wher e pension f unds have been built up and t he capit al value exceeds the lifetime ss.214 - 226 allowance, a tax charge will be levied on the excess. This is called a “lifetime allowance charge”.
The char ge is t r igger ed by a “benefit crystallisation event”, f or example wher e payments are made from the retirement fund, such as t he payment of a pension or a lump sum.
Ther e will be a char ge on t he amount cr yst allised t o t he ext ent t hat payment s f r om t he f und exceed t he lif et ime allowance at t he dat e of t he benef it cr yst allisat ion event . The charge is set at 25% (55% f or lump sums).
The liability f or the lif etime allowance char ge is jointly and severally on the individual member and the scheme administrator. I n pr act ice, t he scheme administ r at or will deduct the relevant tax from the fund and pay it over to the Revenue.
Example 1
Hubert is self employed. He pays £ 500 per mont h int o his pension scheme. He has t axable t r ading pr of it s of £ 42,000 and r eceives bank int er est (net ) of £ 6,000 each year .
Calculat e Huber t ’s t ax payable f or 2006/ 07.
Example 2
Mr Br anst on is Chief Execut ive of a small air line company. He has a salar y of £ 800,000. I n 2006/ 07, Mr Branst on paid £ 200,000 int o t he pension f und r un by his employer . His employer also cont r ibut ed £ 200,000. Mr Br anst on has no ot her income.
Calculat e Mr Br anst on’s t ax liabilit y f or 2006/ 07.
Occupat ional Pensions & Fur bs 415
Answer 1 Non Savings Interest £ £ Trading profits 42,000 Bank interest (x 100/80) 7,500 Less: Per sonal allowance (5,035) _____ Taxable I ncome £ 36,965 £ 7,500
Tax £ 2,150 @ 10% 215 34,815 @ 22% 7,659 4,027 @ 20% 805 40,992 (W) 3,473 @ 40% 1,389 Tax liabilit y 10,068 Less: t ax deduct ed on int er est (7,500 @ 20%) (1,500) Tax due £8,568
Wor king:
Basic r at e t hr eshold £ Original 33,300 Add: gr oss pension cont r ibut ion £500 x 12 x 100/78 7,692 New t hreshold £40,992
Answer 2 Non Savings £ Employment income 800,000 Less: employee pension cont r ibut ions (200,000) Net t axable ear nings 600,000 Less: Per sonal allowance (5,035) Taxable I ncome £ 594,965
Tax £ 2,150 @ 10% 215 31,150 @ 22% 6,853 561,665 @ 40% 224,666 231,734 Add: annual allowance char ge £(400,000 – 215,000) @ 40% 74,000 Tax liabilit y £305,734
416 Principles of Business Taxat ion ‘Finance Act 2006’
SUMMARY - PENSION SCHEMES
Up t o 5 April 2006, t he main ways of pr oviding f unds f or r et ir ement wer e: Company/ occupat ional pension scheme Per sonal pension scheme Ret ir ement annuit y scheme
Fr om Apr il 2006, t hese dif f er ent pension schemes have been abolished and r eplaced wit h one single r egime.
Regist er ed pension f unds do not pay income t ax or CGT and so gr ow t ax-f r ee. At r et ir ement a limit ed t ax-f r ee lump sum (up t o 25%) is t aken and t he r est of t he f und gener at es an annual t axable income f or t he t axpayer dur ing r et ir ement .
The gr oss cont r ibut ion t hat a t axpayer can make int o a pension scheme is t he higher of 100% of his r elevant ear nings f or t he t ax year or £ 3,600.
“Relevant ear nings” includes employment income, t r ading income and income f r om FHLs.
I f t he employer cont r ibut es t o t he scheme t his is a t ax-f r ee benef it , but must be consider ed when looking at t he annual allowance.
Relief is given on amount s cont r ibut ed by t he t axpayer – basic r at e r elief is given at sour ce by t he t axpayer only paying 78% of t he cont r ibut ion. Higher r at e r elief is given by ext ending t he basic r at e band by t he gr oss cont r ibut ion.
Employees can make pension payment s under “net pay ar r angement s” wher eby PAYE is applied t o salar y af t er t he pension cont r ibut ion has been deduct ed.
“Tot al pension input ” f or t he year cannot exceed t he annual allowance. The annual allowance f or 2006/ 07 is £ 215,000. “Tot al pension input ” br oadly means employee’s plus employer ’s pension cont r ibut ions. I ncreases in excess of t he annual allowance ar e subj ect t o t ax char ge of 40%.
The r et ir ement f und which can be built up t o pr ovide t ax-f avour ed benef it s is subj ect t o a lif et ime allowance. The lif et ime allowance is £ 1.5m f or 2006/ 2007.
D14b: THE ENTERPRISE INVESTMENT SCHEME
I n t his chapt er you will cover t he Ent er pr ise I nvest ment Scheme including: - limit s on t he t ax reducer; - carry back of relief ; - qualif ying company; - qualif ying invest or ; - clawback of relief .
St at ut or y r ef er ences ar e t o I CTA 1988 unless st at ed ot her wise.
D14b.1 Introduction
An individual will r eceive t ax r elief in his I ncome Tax comput at ion wher e he subscr ibes f or shar es in a qualif ying EI S company. By “subscribing for shares” s. 289A we mean t hat t he company is issuing new shares to the investor.
I n 2005/ 06 tax relief is restricted to t he lower of t he amount subscr ibed or £ 200,000 and is given by way of a t ax r educer at a f lat r at e of 20%. The s. 290 maximum amount of income t ax r elief t hat an individual can r eceive in 2005/ 06 is t her ef or e: Maximum t ax reducer = £ 200,000 x 20% = £ 40,000
The minimum amount an individual can invest in an EI S company in a t ax year is £ 500.
The t ax reducer is limit ed t o t he individual’s t ax liabilit y f or t he year – i.e. t he EI S r elief cannot cr eat e a “negat ive” f igure f or t he t ax liabilit y. The t ax liabilit y can be reduced t o nil by EI S r elief , leaving t ax deduct ed at sour ce eit her under PAYE or f r om bank int er est , t o be r epaid t o t he t axpayer .
D14b.2 Carry back of relief
I ncome t ax r elief is usually given t o t he invest or in t he year in which t he subscr ipt ion is made. I t is, however , possible to carry back an EIS subscription to the preceding tax year. If an individual subscribes for shares in a qualif ying EI S company before 6 October in the tax year, t he invest or can make an election to carry back the lower of 50% of the amount subscribed or £25,000 to the previous year.
For example, if a t axpayer subscr ibes f or £ 20,000 of shar es on, say, 30 Sept ember 2005, t he t axpayer could elect f or £ 10,000 of t he subscr ipt ion t o be carried back and relieved in t he 2004/ 05 t ax comput at ion.
418 Principles of Business Taxat ion ‘Finance Act 2006’
D14b.3 Qualifying company s. 293
Tax relief will only be given if the individual subscribes for shares in a qualifying EIS company. I t is impor t ant t her ef or e t hat we ar e comf or t able wit h exact ly what is a qualif ying company under t he EI S r ules.
The company must be a t r ading company. Ther ef or e, any company which der ives it s income wholly or mainly f r om making invest ment s is not a qualif ying company f or EI S pur poses.
Ther e ar e certain prohibited or excluded trades f or EI S pur poses. Companies whose act ivit ies ar e pr imar ily financial – by t his we mean companies dealing in shar es or secur it ies or commodit ies et c. - ar e excluded, as ar e companies s. 297(2) pr oviding legal and accountancy ser vices. Farming and market gardening ar e also excluded act ivit ies as is oper at ing or managing hotels, and property development.
I t is possible f or t he company t o be r egist er ed out side t he UK however , t o qualif y f or r elief , t he company’s t r ade must be wholly or mainly car r ied on wit hin t he UK. Most EI S companies will be r esident in t he UK.
The company must be an unquoted company. This means t hat it s shar es must not be mar ket ed t o t he gener al public by being list ed on a r ecognised St ock s. 293(1A) Exchange.
Most companies qualif ying f or EI S r elief ar e r elat ively small t r ading companies and t he EI S r ules place a limit on t he value of t he asset s wit hin t he company. s. 293(6A) The asset s of t he company must not exceed £ 15 million bef or e t he shar e issue and must not exceed £ 16 million af t er t he shar e issue.
Having r aised t he shar e capit al f r om it s invest or s, t he company must use t he cash r aised f or a qualif ying business act ivit y wit hin a cer t ain per iod of t ime. The company must use at least 80% of t he cash r aised f r om t he issue of EI S s. 289(1)(c) eligible shar es wit hin 12 mont hs and t he r emainder wit hin 24 mont hs f or a qualif ying business act ivit y. Qualif ying business act ivit y essent ially means t hat t he company must use it f or some sor t of t r ading pur pose.
Finally, t her e must be no pr e-ar r anged exit s – i.e. t he company must not guar ant ee t he invest or any sor t of r et urn on his investment. Only if the S. 299B invest or is t aking a bona f ide commer cial r isk, will t he Revenue of f er any f or m of tax relief .
The Ent er pr ise I nvest ment Scheme 419
D14b.4 Qualifying investor
Ther e is also one impor t ant qualif ying condit ion as f ar as t he invest or is concer ned. I n or der t o obt ain income t ax r elief , the investor must not be s. 291 connected with the company. Broadly speaking an investor is connected with an EI S company if he br eaches one of t wo main condit ions.
The invest or is connect ed wit h t he company if he is an employee of t he company. The invest or can be a dir ect or of t he company as long as he r eceives only s. 291A r easonable r emuner at ion f or his ser vices.
The invest or is also connect ed t o t he company if he holds more t han 30% of t he or dinar y shar es, or he can exer cise mor e t han 30% of t he vot ing r ight s. I n consider ing whet her t he 30% limit has been br eached, t he shar eholdings of s. 291B associat es must also be consider ed. The associat es her e would include spouses, and ancest or s or r elat ives such as par ent s, siblings and childr en.
D14b.5 Clawback of relief s. 299
Ther e ar e ant i-avoidance pr ovisions t o pr event an invest or f rom obt aining income t ax r elief on his EI S subscr ipt ion, t hen selling t he shar es shor t ly af t er war ds. I f the investor disposes of his shares within three years of issue, there will be a clawback of the income tax relief originally given.
The ef f ect of t his clawback is t o incr ease t he invest or ’s t ax liabilit y in t he year in which he disposes of his shar es. I f t he invest or gives away his shar es wit hin t hr ee year s, all of t he income t ax r elief or iginally obt ained will be wit hdr awn. This will not apply when t he gif t is t o t he invest or ’s spouse.
The clawback of income t ax r elief is slight ly dif f er ent wher e t he shar es ar e sold t o an unconnect ed t hir d par t y. I f t he shar es ar e sold wit hin t hr ee year s, t he income t ax r elief t o be wit hdr awn is t he sale pr oceeds mult iplied by t he r at e at which t ax relief was originally given. I n t he majorit y of instances, t he rate at which t ax r elief was or iginally given will be 20%.
The clawback of income t ax r elief cannot exceed t he or iginal t ax r educer . This means t hat if shar es ar e sold at a pr of it wit hin t hr ee year s of issue, an amount equal t o t he or iginal t ax r educer is added back t o t he invest or ’s t ax liabilit y in t he year of sale.
Illustration 1
I n December 2003 an invest or subscr ibes f or £ 50,000 wor t h of shar es in an EI S company. I n t his inst ance t he invest or would qualif y f or a t ax r educer of £ 10,000 in t he t ax year 2003/ 04.
The invest or disposes of t he shar es in J une 2005 – i.e. wit hin t hr ee year s of t heir issue.
420 Principles of Business Taxat ion ‘Finance Act 2006’
I f t he disposal is by way of a gif t , all of t he t ax relief originally obt ained will be wit hdr awn. This means t hat £ 10,000 will be added t o t he invest or ’s t ax liabilit y in t he t ax year 2005/ 06.
I f t he shar es wer e sold f or £ 60,000, t he I ncome Tax r elief t o be wit hdr awn would again be £ 10,000. Remember t hat when t he EI S shar es ar e sold at a pr of it wit hin t hr ee year s, all of t he or iginal income t ax r elief given will be clawed back in t he year of sale.
On t he ot her hand, if t he shar es wer e sold at a loss wit hin t hr ee year s – her e assume sale pr oceeds ar e £ 40,000 – t he income t ax r elief t o be wit hdr awn is t he sale proceeds, multiplied by 20%. I n this instance, £ 8,000 will be clawed back and added t o t he t ax liability in t he year of sale.
Example 1
Gar y, an employee, had salar y and benef it s t ot alling £ 107,602 in 2005/ 06. He had no ot her income.
I n March 2006 he subscribed £ 230,000 f or shar es in a qualif ying EI S company.
Calculat e his t ax reducer f or 2005/ 06.
Example 2
Which of t he f ollowing t r ades is not an excluded t r ade f or EI S pur poses?
a) Resear ch and development b) Proper t y development c) Shar e dealing d) Mar ket gar dening
The Ent er pr ise I nvest ment Scheme 421
Answer 1
£ Employment income 107,602 Less: per sonal allowance (4,895) Taxable income 102,707
Tax £ 2,090 @ 10% 209 30,310 @ 22% 6,668 70,307 @ 40% 28,123 35,000 Less: t ax r educer (cannot exceed liabilit y) (35,000) Tax liabilit y Nil
Gary subscribed £ 230,000 f or shares in a qualif ying EI S company.
The maximum t ax r educer cannot exceed £ 200,000 x 20% = £ 40,000. However t he t ax r educer cannot exceed t he t ax liabilit y f or t he year. This means t hat t he t ax reducer f or 2005/ 06 will be £ 35,000.
Remember t hat a t ax r educer can r educe a liabilit y down t o nil but cannot it self cr eat e a t ax r epayment .
Note that in this question no carry back is possible as the shares were not subscr ibed f or bef or e 6 Oct ober in t he year .
Answer 2
The answer is A
Resear ch and development is permit t ed. The ot hers are prohibit ed (s.297(2) I CTA 1988)
422 Principles of Business Taxat ion ‘Finance Act 2006’
SUMMARY - THE ENTERPRISE INVESTMENT SCHEME
When an individual subscr ibes f or qualif ying EI S shar es, a 20% t ax r educer is given on t he lower of t he amount subscr ibed or £ 200,000. The t ax reducer is limit ed t o t he individual’s t ax liabilit y.
A subscr ipt ion made bef or e 6 Oct ober can be carried back t o obt ain a t ax reducer in t he pr evious year but t his is limit ed t o t he lower of 50% of t he amount subscr ibed or £ 25,000.
A qualif ying EI S company is an unquot ed t rading company car r ying on it s act ivit ies wholly or mainly in t he UK.
Prohibit ed t r ades include f inancial t r ades, f ar ming, mar ket gar dening, hot el and pr oper t y development .
The company’s asset s must be less t han £ 15m bef or e and less t han £ 16m af t er t he shar e issue. 80% of t he cash r aised by t he issue of EI S shar es must be used f or t he t r ade wit hin 12 mont hs, t he r est wit hin 24 mont hs.
The invest or cannot be connect ed wit h t he company, ie cannot be an employee nor hold >30% of t he shar es, t oget her wit h his associat es.
The t ax r educer is wit hdr awn if t he shar es ar e disposed of wit hin 3 year s. I f t he shar es ar e given away or sold at a pr of it , t he whole t ax r educer is clawed back. I f t he shar es ar e sold at a loss t he claw back is rest rict ed t o t he proceeds x 20%.
E: Value Added Tax
E1: OVERVIEW OF THE VAT SYSTEM
I n t his chapt er we will gain an under st anding of t he gener al pr inciples of VAT.
E1.1 VAT Legislation and interpretation
Value added t ax (VAT) was int r oduced in t he UK on 1 April 1973 by t he Finance Act 1972. Successive Finance Act s have made amendment s t o t he law which has also been consolidat ed, f ir st by t he Value Added Tax Act 1983 (VATA 1983) and subsequent ly by t he Value Added Tax Act 1994 (VATA 1994). The Act s pr ovide t he f r amewor k of t he t ax but much of t he det ail is t o be f ound in st at ut or y inst r ument s, eit her in t he f or m of Or der s made by t he Tr easur y or Regulat ions made by HMRC.
The Gover nment have empower ed Her Maj est y’s Revenue and Cust oms (HMRC) pr eviously known as Cust oms & Excise (but her eaf t er called “Cust oms” in t his t ext ) t o manage t his t ax.
E1.2 European Community legislation
The over r iding law on VAT t hr oughout t he Eur opean Communit y (EC) is in t he EC Dir ect ives, not ably t he 6t h VAT Direct ive. The f or m and met hod of compliance is lef t t o individual EC count r ies but , wher e any of t he pr ovisions ar e mandat or y, EC law t akes pr ecedence if t her e ar e any inconsist encies wit h nat ional law.
E1.3 Interpretation of the law by Customs
Cust oms issue explanat or y not ices on VAT, t oget her wit h VAT not es, news r eleases and business br ief s. These explain how Cust oms int er pr et t he law. Wit h cer t ain except ions, t hese ar e not par t of t he law and t his should be bor ne in mind wher e t he manual indicat es a not ice or leaf let , et c. as sour ce mat er ial.
I f a t axable per son disagr ees wit h t he int er pr et at ion, he has a r ight of appeal, in cer t ain cases, t o a VAT t r ibunal.
E1.4 General Principles of VAT
VAT is a t ax on consumer expendit ur e and is collect ed on business t r ansact ions and impor t s. The basic pr inciple is t o charge VAT at each st age in t he supply of goods and ser vices (out put t ax). I f t he cust omer is r egist er ed f or VAT and uses t he supplies f or business pur poses, he will receive credit f or t his VAT (input t ax). The br oad ef f ect is t hat businesses ar e not af f ect ed and VAT is act ually bor ne by t he f inal consumer .
424 Principles of Business Taxat ion ‘Finance Act 2006’
E1.5 Scope of VAT
A t r ansact ion is wit hin t he scope of UK VAT if all t he f ollowing condit ions ar e met .
• I t is a supply of goods or ser vices. The t er m ‘supply’ is not def ined in t he legislat ion but is br oadly int er pr et ed. Cer t ain t r ansact ions, alt hough supplies, ar e r egar ded as supplies of neit her goods nor ser vices and ar e out side t he scope of UK VAT.
• I t t akes place in t he UK.
• I t is made by a t axable person. A t axable per son is an individual, f ir m or company, et c. which is r egist er ed f or VAT or which is required t o r egist er f or VAT but has f ailed t o do so.
• I t is made in t he cour se or f ur t her ance of any business car r ied on by t hat per son.
A t r ansact ion which does not meet all of t he above condit ions is out side t he scope of UK VAT.
E1.6 Place of supply
To be within the charge to UK VAT, a supply must be made in the UK. Supplies made out side t he UK ar e out side t he scope of UK VAT (alt hough t hey may be liable t o VAT in anot her count r y).
Separ at e r ules apply f or det er mining t he place of supply of goods and ser vices.
E1.7 Time of supply (tax point)
The time at which a supply of goods is t r eat ed as t aking place is called t he t ax point . VAT must nor mally be account ed f or in t he VAT period in which t he t ax point occur s and at t he r at e of VAT in f or ce at t hat t ime. Small businesses can, however , account f or VAT on t he basis of cash paid and r eceived.
The basic t ax point f or a supply of goods is t he dat e t he goods ar e r emoved i.e. sent t o, or t aken by, t he cust omer . I f t he goods ar e not r emoved, it is t he dat e t hey ar e made available f or his use.
The basic t ax point f or a supply of ser vices is t he dat e t he ser vices ar e per f or med.
I n t he case of bot h goods and ser vices, wher e a VAT invoice is r aised or payment is made bef or e t he basic t ax point , t her e is an ear lier act ual t ax point at t he t ime t he invoice is issued or payment r eceived, whichever occur s f ir st .
Overview of t he VAT Syst em 425
Ther e is also gener ally an act ual t ax point wher e a VAT invoice is issued wit hin 14 days af t er t he basic t ax point . This over r ides t he basic t ax point but not t he act ual t ax point cr eat ed by t he issue of an invoice or payment bef or e t he basic t ax point .
Ther e ar e also special pr ovisions f or par t icular supplies of goods and ser vices.
E1.8 Value of supply
The value of a supply is t he value on which VAT is due. The amount of VAT is t hen t he value mult iplied by t he VAT r at e.
The value of a supply nor mally depends upon what is given in exchange f or t he supply, i.e. t he consider at ion. I f t his is wholly in money, t he value will be based on t hat amount . I f not , t he value is t he monet ar y equivalent of t he consider at ion.
Ther e ar e special r ules r elat ing t o discount s of f er ed, t r ansact ions bet ween connect ed per sons and values expr essed in f or eign cur r encies. I mpor t s and acquisit ions f r om ot her EU count r ies also have t heir own valuat ion r ules.
E1.9 Output tax
Out put t ax is t he VAT due on t axable supplies and is normally t he liabilit y of t he per son making t he supply. I n addit ion t o st r aight f or war d business t r ansact ions, out put t ax may also be due on business gif t s and pr ivat e use of own goods and ser vices.
A par t icular supply may be complicat ed by being a mixed supply wher e a single inclusive pr ice is char ged f or a number of separ at e supplies. Wher e t hese supplies ar e t axable at dif f er ent r at es, a f air and j ust if iable appor t ionment of t he t ot al pr ice must be made.
Special schemes for retailers. Tr ader s r egist er ed f or VAT nor mally issue an invoice f or each sale made in or der t o have t he necessar y r ecor ds t o calculat e out put t ax. As t his may be dif f icult or impossible wher e goods ar e sold dir ect ly t o t he public, special schemes ar e available f or use by r et ailer s only.
Second-hand goods. Ther e ar e special pr ovisions f or second-hand goods. Subj ect t o cer t ain condit ions being sat isf ied, under t he Mar gin Scheme VAT is only char geable on t he amount by which t he selling pr ice of a par t icular it em exceeds t he pr ice paid when it was obt ained. The scheme ext ends t o almost t he f ull r ange of second-hand goods. Ther e is also a Global Account ing Scheme which is a simplified scheme for VAT on low value, bulk volume second-hand goods. Under t his scheme, VAT is account ed f or on t he dif f er ence bet ween t he t ot al pur chases and sales of eligible goods in each VAT period rather than on an item by it em basis.
426 Principles of Business Taxat ion ‘Finance Act 2006’
Flat-rate scheme for small businesses. Small businesses wit h t axable t ur nover and t ot al t ur nover below specif ied annual limit s can opt t o j oin a f lat -r at e scheme under which t hey calculat e net VAT due by applying a f lat -r at e per cent age t o t ax-inclusive t ur nover . The f lat -r at e per cent age var ies wit h t he t r ade sect or int o which a business f alls.
Flat-rate scheme for farmers. Far mer s who ar e cer t if ied under t he scheme do not have t o account f or VAT on sales of goods and ser vices wit hin designat ed act ivit ies but ar e not able t o r ecover input t ax incur r ed on pur chases. To compensat e f or t his, f ar mer s in t he scheme may char ge (and r et ain) a f ixed f lat - r at e addit ion of 4% on t op of t he sale pr ice. The cust omer can r ecover t he addit ion as if it wer e VAT.
E1.10 Input tax
A t axable per son is ent it led t o r eclaim input t ax suf f er ed on goods and ser vices supplied t o him, impor t s f r om out side t he EU and acquisit ion of goods f r om ot her EU count r ies pr ovided t hat t he input t ax r elat es t o
• t axable business supplies made by him; or • supplies made by him which ar e out side t he scope of UK VAT but which would have been t axable if made in t he UK; or • cer t ain supplies by him of exempt insur ance and f inancial ser vices t o per sons belonging out side t he EU.
Taxable supplies ar e t hose char geable at t he st andar d, r educed or zer o r at e.
VAT cannot be r ecover ed on goods and ser vices which ar e not used f or business pur poses (e.g. f or pr ivat e use). Wher e goods ar e used par t ly f or business and par t ly f or non-business pur poses, t he VAT incur r ed is nor mally appor t ioned.
VAT incur r ed on a number of it ems is non-deduct ible. These include mot or car s (wit h cer t ain except ions), business ent er t ainment , goods sold under one of t he second-hand schemes and cer t ain ar t icles inst alled in buildings by builder s.
Wher e input t ax has been claimed but t he consider at ion f or t he supply is not paid wit hin six mont hs, t he input t ax must be r epaid t o Cust oms.
Special r ules also apply t o input t ax incur r ed bef or e r egist r at ion f or VAT and af t er der egist r at ion.
E1.11 VAT rates
Ther e ar e cur r ent ly t hr ee main r at es of VAT, a standard rate of 17.5%, a r educed r at e of 5% and a zer o r at e.
The ef f ect of a supply being zer o-r at ed is as f ollows.
• The amount of VAT on t he supply is nil but it is st ill a t axable supply.
Overview of t he VAT Syst em 427
• As a t axable supply, it must be t aken int o account in det er mining whet her r egist r at ion is r equir ed. • I nput t ax may be r eclaimed subj ect t o t he same r ules as f or st andar d- r at ed supplies. • Wher e a supply could be eit her zer o-r at ed or exempt , zer o-r at ing t akes priority.
E1.12 Exempt supplies
Cer t ain supplies ar e exempt f r om VAT. This means t hat no VAT is char geable but , unlike zer o-r at ed supplies, r elat ed input t ax is not r ecover able.
Wher e a per son makes bot h t axable supplies and exempt supplies, he is par t ially exempt and may or may not be able t o r ecover all his input t ax. All input t ax directly attributable to taxable supplies can be r eclaimed but none of t he input t ax dir ect ly at t r ibut able t o exempt supplies (subj ect t o a de minimis limit ). Special r ules t hen apply t o wor k out how much input t ax can be r eclaimed on gener al over heads, et c.
E1.13 Registration
Wher e a per son is in business and making t axable supplies, t he value of t hese supplies is his t axable t ur nover . I f , at t he end of any mont h,
• t axable t ur nover in t he year t hen ended has exceeded a specif ied limit , or • t her e ar e r easonable gr ounds f or believing t hat t he value of t axable supplies in t he next 30 days will exceed a specif ied limit ,
t hat per son nor mally becomes a t axable per son and must not if y Cust oms of his liabilit y t o regist er f or VAT. There are f inancial penalt ies f or f ailing t o do so. Wher e, however , only zer o-r at ed supplies ar e made, Cust oms have a discr et ion t o exempt a per son f r om r egist r at ion.
Even if t axable t ur nover is below t he specif ied limit , a per son who makes t axable business supplies can r equest volunt ar y r egist r at ion.
A per son who is r egist er ed f or VAT ceases t o be liable t o be regist ered and can apply t o be der egist er ed if t he VAT-exclusive value of supplies in t he next t welve mont hs will not exceed a specif ied limit . Even wher e t her e is no liabilit y t o r egist er f or VAT in r espect of UK supplies of goods or ser vices, a liabilit y may ar ise in r espect of
• ‘dist ance selling’ t o non-t axable per sons in t he UK by supplier s in ot her EU count r ies; or
• acquisit ions of goods in t he UK f r om ot her EC count r ies.
428 Principles of Business Taxat ion ‘Finance Act 2006’
E1.14 Imports
Unless special r elief applies, VAT is char ged and payable on t he impor t at ion of goods int o t he UK f r om out side t he EU. The r at e of VAT is t he same as if t he goods had been supplied in t he UK.
Unless t he goods ar e placed under Cust oms war ehousing or cer t ain Cust oms ar r angement s (e.g. f r ee zones, inwar d pr ocessing r elief or Communit y Tr ansit ar r angement s) any VAT due must nor mally eit her be paid at t he t ime of impor t at ion or def er r ed wit h any dut y if t he impor t er or his agent ar e appr oved f or def er ment . VAT paid on t he impor t at ion of goods can be claimed as input t ax, subj ect t o t he nor mal r ules.
E1.15 Exports
Provided var ious condit ions ar e met , goods expor t ed out side t he EU ar e zer o- r at ed.
E1.16 Transactions with other EU countries
The concept s of ‘impor t s’ and ‘expor t s’ of goods apply only t o t r ansact ions wit h count r ies out side t he EU. For int r a-EU movement s of goods, t he t er ms ‘acquisit ions’ and ‘dispat ches’ ar e used. I t is not necessar y t o make an impor t declar at ion on an acquisit ion of goods in t he UK f r om anot her EU count r y or t o pay VAT at t he f r ont ier .
Supplies of goods t o a cust omer r egist er ed f or VAT in anot her EU count r y can be zer o-r at ed pr ovided cer t ain condit ions ar e met . These include obt aining t he cust omer ’s VAT r egist r at ion number and showing it on t he VAT invoice. The cust omer t hen account s f or VAT at t he appr opr iat e r at e on t he goods in t he EU count r y of dest inat ion. I f t he condit ions cannot be met , VAT must be charged in t he count r y of or igin at t he r at e applicable t o t he goods in t hat count r y.
VAT must also be char ged on supplies of goods t o non-r egist er ed cust omer s in ot her EU count r ies. Wher e, however , t he supplier is also r esponsible f or t he deliver y of t he goods, once t he value of such ‘dist ance’ sales t o any par t icular EU count r y exceeds an annual t hr eshold set by t hat count r y, t he supplier is aut omat ically liable t o r egist er f or VAT in t hat ot her count r y. VAT on any f ur t her sales is t hen due in t he EU count r y of dest inat ion.
Special r ules apply t o t r ansf er s of own goods bet ween EU count r ies, goods inst alled or assembled at t he cust omer ’s pr emises, new means of t r anspor t and goods subj ect t o excise dut y pur chased by non-t axable per sons. Ther e ar e also special r ules f or ‘t r iangulat ion’ i.e. wher e a chain of supplies of goods involves t hr ee par t ies and, inst ead of goods physically passing f r om one par t y t o t he next , t hey ar e deliver ed f r om t he f ir st par t y t o t he last par t y in t he chain.
Overview of t he VAT Syst em 429
E1.17 Invoices
A r egist er ed t axable per son must issue a VAT invoice wher e he makes a st andar d or r educed-r at ed supply t o anot her t axable per son in t he UK or a st andar d, r educed or zer o-r at ed supply t o a per son in anot her EU count r y.
E1.18 Returns and payment of VAT
Ever y t axable per son must keep a VAT account summar ising t he out put t ax and input t ax f or each VAT per iod. A VAT per iod is nor mally t hr ee mont hs but a one- mont h per iod is also allowed, par t icular ly wher e input t ax is likely t o exceed out put t ax on a r egular basis.
The inf or mat ion in t he VAT account , plus cer t ain st at ist ical inf or mat ion, must t hen be shown on a VAT r et ur n f or t hat period. The return must be sent to Cust oms any VAT due t o Cust oms paid, no lat er t han one mont h af t er t he end of t he per iod. The due dat e f or payment will be ext ended by seven days wher e payment is made by cr edit t r ansf er . Cer t ain lar ge VAT payer s must make mont hly payment s on account .
Annual accounting. Smaller businesses wit h t ur nover below an annual limit may apply to join the annual accounting scheme. This allows them to complete one VAT r et ur n each year . Mont hly, or wit h t he agr eement of Cust oms, quar t er ly int er im payment s on account ar e r equir ed based on an est imat e of t he amount of VAT due. The annual VAT r et ur n must be complet ed and sent t o Cust oms, wit h any balancing payment , wit hin t wo mont hs of t he end of t he annual VAT account ing per iod.
E1.19 Records
Ever y t axable per son must keep such r ecor ds as Cust oms r equir e. Specif ically, t hese include business and account ing r ecor ds, t he VAT account , copies of all VAT invoices and cr edit not es issued and r eceived, and document at ion r elat ing t o impor t s, expor t s, acquisit ions of goods f r om ot her EC count r ies and goods dispat ched t o ot her EC count r ies. All such r ecor ds must be kept f or six year s unless Cust oms agr ee t o a shor t er per iod.
E1.20 Bad debts
VAT is nor mally due by r ef er ence t o t he t ax point . The supplier must t her ef or e account t o Cust oms f or t he VAT even if t he debt , including t he VAT, is not paid. By way of r elief , VAT can be r eclaimed wher e a debt has been wr it t en of f and six mont hs has elapsed f r om t he dat e of supply and t he dat e payment is due. The pr oblem of VAT on bad debt s can also be r emoved by using t he cash account ing syst em.
430 Principles of Business Taxat ion ‘Finance Act 2006’
E1.21 Cash accounting
Provided turnover is below an annual limit , a t axable per son may, subj ect t o condit ions, account f or and pay VAT on t he basis of cash or ot her consider at ion paid and r eceived. The main advant ages of t he scheme ar e aut omat ic bad debt relief and the def erral of the time f or payment of VAT wher e ext ended cr edit is given.
E1.22 Assessments
Cust oms ar e given power s t o r aise an assessment wher e VAT r et ur ns have not been made or it appears to them that r et ur ns ar e incomplet e or incorrect . The assessment must nor mally be made wit hin t wo year s f r om t he end of t he r et ur n per iod in quest ion or , if lat er , wit hin one year of t he f act s on which t he assessment is based coming t o t heir knowledge. An assessment cannot be r aised mor e t han t hr ee year s af t er t he end of t he r et ur n per iod except in cases of f r aud when t he per iod is ext ended t o 20 year s. Wher e t he t axable per son has died, an assessment cannot be made mor e t han t hr ee year s af t er deat h or r elat e t o a per iod mor e t han t hr ee year s bef or e deat h.
E1.23 Interest and penalties
I nt er est is char geable in cer t ain cir cumst ances wher e VAT has been under declar ed or over claimed. On t he ot her hand, r epayment supplement is due wher e Cust oms do not make a r epayment on t ime and int er est can be paid t o t he t axpayer wher e VAT has been over paid or under claimed as a r esult of er r or by Cust oms.
Ther e is an ext ensive r ange of cr iminal and civil penalt ies. Liabilit y f or cer t ain civil penalt ies can be avoided wher e t here is r easonable excuse f or conduct and penalt ies can be mit igat ed by Cust oms or a VAT t r ibunal.
E1.24 Appeals
An appeal against a decision of Cust oms on cer t ain mat t er s may be made t o t he appeal body and from there, on a point of law, to the High Court (Court of Session in Scot land) and cont inued up t o t he House of Lor ds under nor mal pr ocedur e. The mat t er s on which an appeal may be made ar e r est r ict ed and cer t ain condit ions must be complied wit h. Not ably, unless Cust oms agr ee ot her wise, t he appellant must have made all t he r et ur ns he is r equir ed t o make and paid over t he VAT due accor ding t o t hose r et ur ns. Not ice of t he appeal must be ser ved wit hin 30 days of t he disput ed decision.
Overview of t he VAT Syst em 431
SUMMARY – OVERVIEW OF VAT SYSTEM
Alt hough VAT is ult imat ely suf f er ed by t he f inal consumer in a chain of t r ansact ions t he way t hat t he VAT syst em wor ks is t hat VAT is collect ed piecemeal at ever y st age in t hat long chain. So, ef f ect ively, t her e is a payment on account syst em.
At each point in t he chain t he supplier charges t he appr opr iat e out put t ax t o t he next per son in t he chain and r ecover s any input t ax he paid t o t he pr evious per son in t he chain.
This ser ies of out put t ax less input t ax account ing of VAT will occur r ight up unt il t he f inal sale t o t he member of t he public or t he ult imat e consumer .
However , alt hough VAT is collect ed piece by piece along t he chain of t r ansact ions ult imat ely it is t he f inal consumer who bears t he f ull cost of t he VAT being collect ed. I n ot her wor ds, t he out put t ax char ged t o t hat f inal consumer will equal all t he net VAT account ed f or dur ing t he j our ney which t ook t hose goods or ser vices t o t hat ult imat e consumer .
E2: REGISTRATION
This chapt er looks at r egist r at ion of a business f or VAT and includes: compulsor y r egist r at ion; volunt ar y r egist r at ion; de-r egist r at ion; exempt ion f r om r egist r at ion; disaggr egat ion.
E2.1 Introduction
I n t his chapt er we will look at r egist r at ion f or VAT. Not all businesses must be r egist er ed f or VAT but , if you ar e in business making t axable supplies, you will be r equir ed t o be r egist er ed by Cust oms if , at t he end of any calendar mont h, t he value of t axable supplies made in t he pr evious 12 mont hs exceeds Sch 1 t he annual r egist r at ion t hr eshold. Alt er nat ively, you must r egist er f or VAT if Par a 1 at any t ime t her e ar e r easonable gr ounds f or believing t hat t he value of t axable supplies t o be made in t he next 30 days on t heir own, will exceed t he annual r egist r at ion t hr eshold.
Ther e ar e t wo t est s and Cust oms will use t he t est which gives t he ear lier r egist r at ion dat e.
Ther e ar e a f ew t er ms t o get t o gr ips wit h here; t he f irst one will be ‘taxable supplies’ as def ined by Cust oms. Cer t ain t r ansact ions ar e t axable i.e. VAT is char geable at a cer t ain r at e. However it is only when you exceed a cer t ain level of t axable supplies t hat you have t o r egist er and act ually account f or VAT on t hose t axable supplies.
Anot her t er m used is t he ‘annual registration threshold’. This changes ever y year wit h t he Budget and t he cur r ent r at e is £ 61,000. So if , f or example, my t axable supplies f or t he 12 mont hs t o 30 April 2006 were £ 62,000 I would have an obligat ion t o r egist er .
Whilst t he above ar e compulsory registration t est s, it is possible t o voluntarily register f or VAT. Any bona f ide business whose taxable turnover is below the annual t hr eshold can apply t o r egist er volunt ar ily. So, f or example, I might have t axable supplies of say £ 30,000 a year , which is below t he compulsor y limit s, but I may choose t o r egist er . I might do t his f or a number of r easons, one of which is credibility. For example, if I did not char ge VAT on my invoices, t hen my cust omer s would know t hat my t ur nover is quit e small. So many businesses j ust r egist er t o add cr edibilit y or conceal t ur nover .
Anot her r eason t o r egist er would be t o recover your input VAT. As we saw in Chapter 1, when you charge output VAT on your supplies or your sales, you are ent it led t o r eclaim your input VAT, t hat is VAT which has been char ged t o you on your cost s. So t his might be quit e an impor t ant r eason f or r egist er ing f or VAT.
Regist rat ion 433
If your customers are registered businesses t hemselves, t her e would be a ver y st r ong incent ive t o r egist er because your cust omer s would not mind you char ging VAT, since t hey will claim it back as their input tax. I t is only r eally when your cust omer s ar e t he public t hat a small business must t hink quit e ser iously about whet her it should r egist er volunt ar ily or not .
E2.2 Types of Registration
I n summar y, r egist r at ion can be br oken down int o a compulsor y r egist r at ion or a volunt ar y r egist r at ion. The compulsor y r egist r at ion t est can be br oken down int o an hist or ic t est and a f ut ur e t est . For t he hist or ic t est at t he end Sch 1 of ever y calendar mont h, you look at t axable supplies in t he pr evious 12 Par a 1 mont hs and if you have exceeded t he annual t hr eshold, cur r ent ly £ 61,000, t hen you have an obligat ion t o r egist er .
I n t he f ut ur e t est you look f or war d 30 days and if t he business is expect ed t o exceed £ 61,000 of t axable supplies in t he next 30 days, t hen you would have an obligat ion t o r egist er . I t is impor t ant t o r ecognise t hat t he f ut ur e t est is a daily t est , so ever y single day you must look f or ward 30 days and see if in t he next 30 days you will exceed £ 61,000. I t makes no reference to what went on bef ore t oday. I t is t he next 30 days on their own t hat mat t er s.
For volunt ar y r egist r at ion exist ing t r ader s can r egist er even if t heir t axable supplies f all below t he limit s. Anot her f or m of volunt ar y r egist r at ion is f or int ending t r ader s. These ar e t r ader s who have not act ually commenced t r ading, but who int end t o wit hin t he f or eseeable f ut ur e. These t r ader s would apply t o Cust oms f or a VAT number well bef or e t hey commence t r ading. Sch 1 This might be f or a number of f act ors but t he most common is t o enable Par a 9 r ecover y of VAT f r om Cust oms whilst t he business is being set up. For example, it might t ake you 6 mont hs t o r ef it a shop but in t hose 6 mont hs, if you ar e r egist er ed f or VAT, you can r eclaim input t ax f r om Cust oms. These would obviously be pr ovisional r eclaims and will be dependent on t he f act t hat you do act ually commence t r ading.
Regist r at ion
Compulsor y Volunt ar y
Historic Fut ur e Exist ing I nt ending t est t est trader trader
434 Principles of Business Taxat ion ‘Finance Act 2006’
E2.3 Historic test
As we have seen, you will be r equir ed t o r egist er f or VAT if at t he end of any Sch 1 calendar mont h, t he value of your taxable supplies in the last 12 months Par a 1 exceeds £ 61,000, t he cur r ent annual t hr eshold.
I f you have exceeded t he limit t hen you must not if y Cust oms of your Sch 1 r equir ement t o be r egist er ed by complet ing f or m VAT 1 and submit t ing it t o Par a 11 t o 17 Cust oms wit hin 30 days of t he mont h t hat you exceeded t he limit . The SI 1995/ 2518 r egist r at ion will be ef f ect ive i.e. you will be regist ered f rom, t he f irst day of Reg 5 t he second mont h f ollowing t he end of t he mont h t he £ 61,000 was exceeded.
For example, at t he end of J une a business exceeds t he limit s t hen it must be r egist er ed f r om t he 1st day of t he second mont h f ollowing J une. As J uly is not t he second mont h, it must be August . So t he business must be r egist er ed f r om t he 1st day of August. It exceeded the limit in June, it will have July ef f ect ively f r ee of VAT and f r om 1 August it is r egist er ed.
Illustration 1
Let us assume we ar e a t r ader in business and we ar e checking at t he end of ever y calendar mont h t he t axable supplies in t he pr evious 12 mont hs. At t he end of Apr il 2006 my t axable supplies amount ed t o £ 55,000 f or t he pr evious 12 mont hs, so t her e is no r equir ement f or t he business t o be r egist er ed.
We t hen go t o t he end of May 2006 and, f or t he pr evious 12 mont hs t o May, t he t axable supplies amount ed t o £ 58,000; again below t he limit s. We t hen go t o the end of June and, if we look back 12 mont hs, t he t axable supplies amount t o £ 54,000. A f all in t he value of t axable supplies like t his is simply as a r esult of t he J une 2006 t axable supplies being lower t han t he J une 2005 t axable supplies. But , in any event , we ar e below t he £ 61,000 limit and t her e is no r equir ement t o r egist er .
We t hen go on t o t he end of J uly 2006 and f or t he pr evious 12 mont hs our t axable supplies amount t o £ 62,000. The business has exceeded t he limit s; it has a r equir ement t o r egist er .
Example 1
The business ment ioned in I llust r at ion 1 must not if y Cust oms of it s r equir ement t o r egist er f or VAT on f or m VAT 1.
By which dat e must Cust oms be not if ied?
Fr om which dat e will t his business be VAT r egist er ed?
Regist rat ion 435
Illustration 2
New Business Limit ed commenced t r ading on 1 J uly 2005. The t axable sales wer e as f ollows: £ £ 2005 July 4,000 2006 March 5,000 August 4,000 April 5,000 September 4,000 May 5,000 Oct ober 4,000 J une 6,000 November 4,000 July 8,500 December 4,000 August 8,000 2006 J anuar y 4,000 Sept ember 7,000 Febr uar y 4,000 Oct ober 8,500
I shall assume t hat t his business does not want t o volunt ar ily r egist er . I need t o f ind out when t he compulsor y r egist r at ion limit of £ 61,000 is exceeded.
At t he end of every calendar mont h I look back 12 mont hs. I f I have not got 12 months to look back to, for example, on a st ar t -up, I can only look back t o t he st art of t rade. So at t he end of July 2005 I look t o see how much I have sold in t he previous 12 months. I have sold £ 4,000; so no requirement t o regist er. I t hen move on t o August 2005; t axable supplies in t he pr evious 12 mont hs, will be £ 8,000. This pr ocess will cont inue unt il I exceed t he £ 61,000 limit .
We can see f r om t his example t hat when I get t o J une 2006, t axable supplies t o J une 2006 t ot al £ 53,000. Thus, r egist r at ion is not r equir ed. The 12 mont hs t o J uly 2006 amount t o £ 57,500; again not exceeding t he limit .
At t he end of August 2006, in t he pr evious 12 mont hs, my cumulat ive t axable supplies amount t o £ 61,500; t hat exceeds t he limit of £ 61,000 so August 2006 is t he mont h t he limit has been exceeded and t he dat e t he business must not if y Cust oms of it s r equir ement t o be r egist ered is 30 Sept ember 2006, t hat is 30 days af t er t he mont h t he limit was exceeded.
The compulsor y r egist r at ion dat e will be 1 Oct ober 2006, t hat is t he f irst day of t he second mont h f ollowing t he mont h t he limit was exceeded. So Sept ember has been f r ee of VAT and t he f ir st t ime t he business will have t o char ge VAT is f rom 1 Oct ober 2006.
E2.4 Future Test
This is a t est which applies at any t ime. So ever y single day, t he t r ader must ask himself whet her t her e ar e r easonable gr ounds f or believing t hat t he value Sch 1 of t axable supplies in t he next 30 days will exceed t he r egist r at ion limit . Par as 1 and 6 Not if icat ion must again be made on f or m VAT 1 and again wit hin 30 days.
The registration on t he f ut ur e t est does, however , have an immediate effect. So st raight away you must charge VAT even t hough you will have no VAT number at t hat point .
436 Principles of Business Taxat ion ‘Finance Act 2006’
This f ut ur e t est is r eally t o cat ch subst ant ial or der s. So, f or example, if you ar e always below t he hist or ic t est but t oday you went int o t he of f ice and r eceived an or der f or £ 100,000 which you wer e going t o t ur n ar ound pr et t y quickly, t hen t oday you know t hat in t he next 30 days on t heir own, you would exceed £ 61,000. You have got an or der f or £ 100,000 so t her ef or e you must exceed t he limit in the next 30 days. Consequently you must notify Customs within 30 days from t oday and you must be r egister ed f or VAT f r om t oday.
Illustration 3
Let us look at an illust r at ion wher e we have a business t hat has always t r aded j ust below t he hist or ic t hr eshold. I n t he 12 mont hs t o 30 Apr il, t he t axable supplies wer e £ 58,000; t he 12 mont hs t o 31 May t he t axable supplies wer e £ 59,000; t he 12 mont hs t o 30 J une, t hey wer e £ 57,000. I n ot her wor ds t he business is always j ust below t he limit s.
Let us assume t hat t his business r eceived an or der on 10 J uly f or £ 70,000. They have got t he goods in st ock and t hey expect t o t ur n t he or der ar ound within 10 days. So on 10 July if you look f or war d 30 days, you will exceed t he limit of £ 61,000. You have got an or der f or £ 70,000 plus what ever sales you would or dinar ily do in t hose 30 days. So t he business br eaches t he f ut ur e t est .
When must t his business not if y Cust oms of it s r equir ement s t o r egist er ? The not if icat ion dat e is 30 days f r om 10 J uly. That was t he point when you could say t hat t her e wer e r easonable gr ounds f or believing t hat t axable supplies in t he next 30 days would exceed t he limit s. So 9 August 2006 is 30 days.
This business must be r egist er ed f r om what dat e? As we saw ear lier , t he dat e of r egist r at ion f or t he f ut ur e t est is immediat e so on 10 J uly t his business must be r egist er ed f or VAT, i.e. it must char ge VAT f r om 10 J uly.
E2.5 Common Misconception
J ust one point t o make about a common misconcept ion on t he hist oric and t he f ut ur e t est s. This is best illust r at ed using an example. Let us say t axable sales in t he 11 mont hs t o 30 Sept ember 2006 were £ 55,000. I n Oct ober 2006 you have budget ed sales of £ 7,000. I n t his sit uat ion t he f ut ur e t est does not apply because t her e is no point at which you can say in t he next 30 days on their own, t he business will exceed t he limit s. On 1 Oct ober 2006 we ant icipat e t axable supplies f or Oct ober of £ 7,000 and £ 7,000 alone does not exceed £ 61,000 so t her ef or e t he f ut ur e t est does not apply.
The hist or ic t est will however apply when I get t o t he end of Oct ober. The t axable supplies made in t he 12 months t o 31 October amount t o £ 62,000. The business has exceeded t he limit s. I t must notify Customs by 30 days from the mont h of excess, so 30 November 2006. The r egist r at ion dat e will be 1 December 2006 so no VAT is char ged f or t he whole of November , and t he business is r egist er ed f r om t he f ir st day of t he second mont h, so 1 December .
Regist rat ion 437
E2.6 Taxable supplies
A t axable supply is a supply of goods or ser vices made in t he UK ot her t han an exempt supply. I n det er mining whet her t he r egist r at ion limit s have been exceeded, it is t her ef or e necessar y t o t ake int o account t he VAT-exclusive value s.4(2) of all st andar d and zer o-r at ed supplies of goods and ser vices, including
• t he value of ‘reverse charge’ ser vices r eceived f r om abr oad (Chapt er 23); and • t he value of any self-supplies (Chapt er 7).
The f ollowing special r ules, however , apply.
• Supplies of goods or ser vices t hat ar e capital assets of t he business in t he cour se or f ur t her ance of which t hey ar e supplied ar e t o be Sch 1 par a disr egar ded. Specif ically, however , any st andar d-r at ed supply of an 1(7)(8) int er est in, r ight over , or licence t o occupy land is not t o be r egar ded as a capit al asset and does f or m par t of t he per son’s t axable supplies f or r egist r at ion pur poses.
Capit al asset s may be t angible or int angible and include pr emises, plant , machiner y, of f ice machiner y, comput er s, of f ice f ur nit ur e, used company car s, pat ent r ight s which have been exploit ed and which ar e sold out r ight , and goodwill.
• Supplies can be disr egar ded if t hey ar e only t axable supplies in t he UK Sch 1 par a because an over seas business makes dist ance sales t o non-t axable 1(7) per sons in t he UK and is r equir ed t o r egist er under VATA 1994, Sch 2.
The value of any dist ance sales wher e t he place of supply is consider ed t o be in anot her EU country must also be excluded when calculating t axable t ur nover .
• Under t he schemes f or second-hand goods, t he t axable supplies ar e t he f ull selling pr ices of t he goods. Under t he tour operators’ margin scheme, t axable supplies ar e t he t ot al mar gin (i.e. dif f er ence bet ween buying pr ices and t he selling pr ices) on mar gin scheme supplies plus t he f ull value of any ot her t axable supplies (including all in-house supplies).
E2.7 Deregistration
Once a business is registered for VAT, it is not always the case that it will r emain r egist er ed f or VAT. I n cer t ain sit uat ions a business may be r equir ed Sch 1 t o der egist er or may volunt ar ily der egist er . Examples of compulsor y Par a 11 der egist r at ion would be:
438 Principles of Business Taxat ion ‘Finance Act 2006’
• Sale of business - if you sold your business you ar e no longer in a posit ion t o char ge VAT so you ar e compulsor ily der egist er ed;
• Changing status – a business might change f r om a sole t r ader t o a limit ed company f or example.
• Ceasing to make taxable supplies - a business may cease t r ading f or example.
Volunt ar y der egist r at ion is available wher e a business is expect ed t o make taxable supplies in the next 12 months of less than £ 59,000. I f that is the Sch 1 case, and t he business no longer wishes t o r emain r egist er ed, it can inf or m Par a 1(3) Cust oms and pr oviding t hey ar e sat isf ied t hat t he business will f all below t he deregistration limit of £ 59,000 it will be per mit t ed t o der egist er .
However , t hat per son does not cease t o be liable t o be r egist er ed under t hese pr ovisions if Cust oms ar e sat isf ied t hat t he r eason t he value of his t axable Sch 1 supplies will not exceed t he above limit is t hat in t he per iod in quest ion he will Par a 4(2) cease making t axable supplies or will suspend making t hem f or a per iod of 30 days or mor e.
Taxable supplies f or t he above pur poses ar e det er mined on t he basis t hat no Sch 1 par as VAT is char geable on t he supply (i.e. VAT-exclusive). 3,4,15,16
When der egist er ing VAT must be account ed f or on t he f inal r et ur n of any ‘goods’ f or ming par t of t he business asset s which ar e on hand at t he close of business or on the last day of registration as if they were supplied in the course or f ur t her ance of t he business unless
(a) t he business is t r ansf er r ed as a going concer n t o anot her t axable per son;
(b) t he t axable per son has died, become bankr upt or incapacit at ed and t he business is car r ied on by anot her per son who under VATA 1994, s 46(4) is t r eat ed as a t axable per son; or
(c) t he VAT on t he deemed supply would not be mor e t han £ 1,000.
‘Goods’ f or t hese pur poses means t angible goods (e.g. unsold st ock, plant , f ur nit ur e, commer cial vehicles, comput er , et c.) and int angible goods such as pat ent s, copyr ight s and goodwill can be disr egar ded. I t includes goods pur chased VAT Not ice wher e t it le has not yet passed t o t he business but wher e input t ax on t he 700/ 11/ 02, pur chase has been allowed (e.g. goods on hir e pur chase or lease pur chase and par a 6.1 goods subj ect t o r eser vat ion of t it le). Land f or ming par t of t he business asset s is t r eat ed as if it wer e goods.
The pr ovisions do not apply t o any goods wher e t he t axable per son can show t o t he sat isf act ion of Cust oms t hat
Regist rat ion 439
(i) no cr edit f or input t ax has been allowed t o him in r espect of t he supply of goods, t heir acquisit ion f r om anot her EU count r y or t heir impor t at ion f r om a place out side t he EU; and (ii) t he goods did not become his as par t of t he asset s of a business t r ansf er r ed as a going concer n f r om anot her t axable per son.
The pr ovisions also do not apply wher e a per son ceased t o be a t axable per son in Sch 4 consequence of being cer t if ied t o j oin t he f lat r at e scheme f or f ar mer s. par as 8 & 9
The f ollowing ar e excluded f r om t he char ge t o VAT:
• Goods bought f r om unr egist er ed businesses.
• Mot or car s (except qualif ying car s on which input t ax has been claimed).
• Goods bought under t he pr ovisions of one of t he second-hand schemes.
• Goods used wholly f or business ent er t ainment .
• Goods t hat have been dir ect ly at t r ibut ed t o an exempt business act ivit y (unless t he input t ax was r eclaimable t hr ough t he par t ial exempt ion r ules).
• Goods not bought f or business pur poses.
• Land or buildings which wer e pur chased under an exempt supply even t hough
(i) t he opt ion t o t ax has been exer cised and subsequent ly st andar d- r at ed supplies have been made and/ or input t ax r ecover ed on t he r ef ur bishment of t he building; or
(ii) without the option to tax they have ot her wise been used t o make st andar d-r at ed supplies (e.g. holiday accommodat ion).
• Land or buildings which wer e pur chased under a supply on which VAT was r ecover ed (e.g. wher e a f ully t axable business buys a new commer cial pr oper t y) if at t he t ime of der egist r at ion t he sale would be exempt (because t he business has not opt ed t o t ax t he propert y which is t hen over t hr ee year s old). I n such cir cumst ances, VAT due on t he supply of t he pr oper t y would be nil and so not exceed t he £ 1,000 limit .
Wher e a business has st andar d-r at ed land or buildings on hand at t he t ime of der egist r at ion on which it claimed input t ax deduct ion, t he pr oper t y is deemed t o VAT Not ice be supplied on der egist r at ion. To avoid t he cash f low pr oblem t hat t his might 700/ 11/ 02, cr eat e, t he business could def er t he cancellat ion of r egist r at ion unt il t he Par a 6.2; pr oper t y is sold so t hat it would t hen be r equir ed t o account f or out put t ax on Manual VI -3, t he act ual sale of t he pr oper t y. Cust oms ar e pr epar ed t o consider , if necessar y, Chapt er 2A def er r ing t he cancellat ion of r egist r at ion longer t han t he nor mal six mont hs, par a 4.9 unt il af t er t he pr oper t y is sold.
440 Principles of Business Taxat ion ‘Finance Act 2006’
E2.8 Exemption from registration
Wher e a per son who makes or int ends t o make t axable supplies sat isf ies Cust oms t hat ‘any such supply’ is zero-rated (or would be so if he wer e a t axable per son) t hey may, if he so r equests and t hey t hink f it , gr ant exempt ion f r om r egist r at ion under t he above pr ovisions. On a mat er ial change in t he nat ur e of t he supplies made, t he per son exempt ed must not if y Cust oms of t he change wit hin 30 days of t he end of t he day on which it occurred or, if no par t icular day is so ident if iable, Sch 1 par a 14 wit hin 30 days of t he end of t he part icular quar t er in which it occur r ed. On a mat er ial alt er at ion in any quar t er in t he pr opor t ion of t axable supplies of such a per son t hat ar e zer o-r at ed, he must not if y Cust oms of t he alt er at ion wit hin 30 days of t he end of t hat quar t er . Exempt ion applies unt il it appear s t o Cust oms that the request should no longer be act ed upon or t he r equest is wit hdr awn by t he t rader.
‘Any such supply’ has it s or dinar y meaning and Cust oms t her ef or e have discr et ion in applying t he pr ovisions wher e not all of t he supplies ar e zer o-r at ed. Cust oms will t her ef or e exempt a per son f r om r egist r at ion if only a small pr opor t ion of his t axable supplies is st andar d-r at ed pr ovided t hat , if r egist er ed, input t ax would nor mally exceed out put t ax.
Cust oms will consider applicat ions f r om unr egist er ed per sons who have r eached t he r egist r at ion t hr eshold and f r om per sons who ar e alr eady r egist er ed. Unr egist er ed applicant s ar e st ill r equir ed t o complet e f or m VAT 1.
A mat er ial alt er at ion af f ect ing exempt ion f r om r egist r at ion would ar ise wher e, if t he per son was r egist er ed, out put t ax would exceed input t ax in any t welve mont h per iod.
Exempt ion saves a per son t he t r ouble and expense of having t o keep pr oper r ecor ds and account s f or VAT pur poses and r ender ing r et ur ns but it does mean t hat input t ax paid on pur chases of goods or ser vices f or t he business is not r eclaimable.
Disaggr egat ion of business act ivit ies
The disaggr egat ion pr ovisions ar e designed t o pr event t he maint enance or cr eat ion of any ‘ar t if icial’ separ at ion of business act ivit ies car r ied on by t wo or mor e per sons f r om r esult ing in t he avoidance of VAT. For example a builder might have a VAT r egist er ed company dealing wit h his lar ger cont r act s and an unr egist er ed par t ner ship wit h his wif e dealing wit h t he smaller maint enance wor k. I f t he par t ner ship wer e mainly dealing wit h t he public t her e would be a Sch 1 par a compet it ive and f inancial advant age f r om t r ading in t his way. 2(1)
I n det er mining whet her any separ at ion of business act ivit ies is ‘artif icial’, consider at ion must be given t o t he ext ent t o which t he dif f er ent per sons car r ying on t hose act ivit ies ar e closely bound t o one anot her by financial, economic and organisational links.
Regist rat ion 441
Cust oms may make a dir ect ion under which t he per sons specif ied t her ein become t r eat ed as a single t axable per son car r ying on t he act ivit ies of a business described in t he direct ion. That t axable per son is t hen liable t o be r egist er ed under VATA 1994, Sch 1 wit h ef f ect f rom t he dat e of t he direct ion or such lat er day as is specif ied.
I f , immediat ely bef or e t he dir ect ion any per son named t her ein is alr eady Sch 1 par a 1A registered in respect of taxable supplies made by him, he ceases to be liable to Par a 2(1)(3)- be r egist er ed f r om t he dat e of t he dir ection or, if later, the date with ef f ect (5); f r om which t he single t axable per son concer ned became liable t o be r egist er ed.
442 Principles of Business Taxat ion ‘Finance Act 2006’
Answer 1
The correct not if icat ion dat e is 30 August 2006. This is 30 days f r om t he mont h in which t he limit s wer e exceeded.
As t he business exceeds t he limit s at t he end of J uly 2006, t he correct r egist r at ion dat e is 1 Sept ember 2006; t his is t he f irst day of t he second mont h. Thus August was f r ee of VAT and no VAT needs t o be char ged in August . However f r om 1 Sept ember t he business will be r egist er ed and t hen must char ge VAT.
Regist rat ion 443
SUMMARY - REGISTRATION
Ther e ar e t wo t ypes of r egist r at ion - compulsor y and volunt ar y r egist r at ion.
For compulsor y r egist r at ion t her e ar e t wo t est s which must be consider ed – t he hist or ic t est and t he f ut ur e t est .
The hist or ic t est looks at past t axable supplies but we never look back mor e t han t he pr eceding 12 mont hs. This hist or ic t est is car r ied out at t he end of ever y calendar mont h. I f t he cumulat ive t axable supplies exceeds t he VAT r egist r at ion limit t hen Cust oms must be not if ied wit hin t he next 30 days and we r egist er t he business f r om t he st ar t of t he second mont h t hat f ollows t he mont h end.
The future test looks only at taxable supplies in the next 30 days alone. If the r egist r at ion limit is exceeded t hen Customs must be notified before that 30 day per iod expir es. The business will t hen be regist ered f rom t he st art of t he 30 day per iod.
Volunt ar y r egist r at ion allows a business t o r egist er f or VAT even if it s t axable supplies does not exceed t he VAT r egist r at ion t hr eshold. Volunt ar y r egist r at ion is also available f or int ending t r ader s who have not yet commenced t o t r ade but ar e int ending t o do so in t he near f ut ur e.
De-r egist r at ion allows a business t o de-r egist er f or VAT. De-r egist r at ion may be compulsory or volunt ary. Compulsory de-r egist r at ion would occur wher e a business is sold or ceases t o make t axable supplies. Volunt ar y de-r egist r at ion is available wher e a business is expect ed t o make t axable supplies in the next 12 months of less than £ 59,000.
Tr ader s who make zer o r at ed supplies may r equest t o be exempt f r om r egist r at ion.
Cust oms have t he power t o dir ect t hat businesses t hat have close f inancial, economic and or ganisat ional links ar e aggr egat ed f or t he pur poses of r egist r at ion. The dir ect ion will nor mally be applied wher e businesses ar e separ at ed in or der t o avoid char ging VAT on some or all of t he business t ur nover .
E3: DEFINITION OF SUPPLIES
This chapt er will look at t he f ollowing: - when a supply ar ises f or VAT pur poses; - t he def init ion of consider at ion; - t he f ive basic condit ions r equir ed t o det er mine whet her a supply should be charged t o VAT.
E3.1 Introduction
A supply f or VAT pur poses would gener ally ar ise wher e consider at ion is given in s.5(2) r et ur n f or goods or ser vices.
Consideration is any form of payment, be it cash or in kind. Suppose we have a r egist er ed t r ader t hat sells goods t o a cust omer (t he supply). I n r et ur n, t he cust omer pays cash t o t he r egist er ed t r ader (consider at ion). Wher e t he consider at ion is f or t he goods pr ovided, we have a supply f or VAT pur poses.
I t is not however necessar y f or cash t o pass; t he def init ion of consider at ion says payment in money or in kind, so it need not be money. For example, in r et ur n f or t he goods t he cust omer may of f er his t ime i.e. he may have an ar r angement wher e he wor ks one mor ning a week in t he r egist er ed t r ader ’s business. He would not get paid f or t hat morning inst ead he receives goods. So t he consider at ion in t his example would be t he t ime t he cust omer is giving t he r egist er ed t r ader , hence t her e will be a supply f or VAT and t he r egist er ed t r ader must det er mine whet her he should char ge VAT on t he goods supplied. This will depend on whet her t he goods supplied ar e t axable or not .
Consequent ly once consider at ion is pr esent and dir ect ly linked t o a supply, we t hen need t o det er mine whet her it is a taxable supply.
E3.2 Five Conditions
Ther e ar e f ive basic condit ions t o det er mine whet her a supply mer it s a char ge s.4 t o VAT.
a) The supply must amount t o a supply of goods or services. b) The supply must be made by a taxable person. c) The supply must have been made in t he United Kingdom. d) The supply must have been made in the course or furtherance of business. e) I t must be a taxable supply by def init ion.
We shall now consider each of t hese in t ur n.
Def init ion of Supplies 445
E3.3 Goods or Services
A supply of goods is def ined in t he legislat ion as t he t r ansf er of t he whole of Sch 4 pr oper t y in goods by way of sale, hir e pur chase, condit ional sale or similar Par a 1 t r ansact ion. This is ef f ect ively exclusive owner ship passing. Take car e wit h t he supply of any f or m of power , heat , r ef riger at ion or vent ilat ion, t he gr ant , Sch 4 assignment or sale or sur r ender of t he f r eehold or a leasehold exceeding 21 Par as 3 & 4 year s - all t he above ar e deemed t o be supplies of goods.
Anyt hing done f or consider at ion which does not f all wit hin t he above is a supply s.5(2) of ser vices. So t her e is no r eal def init ion of ser vices. Ther e is a def init ion of goods but if your par t icular t r ansact ion does not f all wit hin t his def init ion, t hen it will be a ser vice.
For example, if you ar e a r et ailer who sells a comput er t o a cust omer , t hat will be a supply of goods as exclusive owner ship is passing. I f , on t he ot her hand, t he r et ailer r et ains owner ship of t he comput er and leases it or rents it to the cust omer , t hat is a ser vice.
E3.4 Supply must be made by a Taxable Person
The second condition is that the supply must be made by a taxable person. A t axable per son f or VAT pur poses is any individual (i.e. a sole t r ader ), any s.3 par t ner ship, company, club or associat ion which is or is r equir ed t o be r egist er ed f or VAT. So t his is basically any per son who has exceeded t he compulsor y r egist r at ion t est s or has r egist er ed f or VAT volunt ar ily.
E3.5 UK Supply
The t hir d condit ion is t hat t he supply must be made in the United Kingdom. Subj ect t o var ious over r ides, if t he supply of any goods does not involve t heir s.7(2) r emoval f r om or t o t he UK t hey shall be t r eat ed as supplied in t he UK if t hey ar e in t he UK and ot her wise shall be t r eat ed as supplied out side t he UK.
Ser vices ar e deemed t o be supplied in t he count r y in which t he supplier belongs, i.e. a count r y in which he has his business est ablishment or if t her e is no such s.7(10) est ablishment in t he count r y in which he r esides. So, f or example, a UK lawyer will be deemed t o belong in t he UK, t her ef or e his ser vices ar e supplied in t he UK.
Ther e ar e var ious over r ides t o t hese basic r ules which will be cover ed lat er in t he t ext but , f or now, we will j ust st ick wit h t hese basic pr inciples.
446 Principles of Business Taxat ion ‘Finance Act 2006’
E3.6 In Course or Furtherance of the Business
The next condit ion is t hat t he supply must be made in t he cour se or f ur t her ance
of t he business.
Despit e t he impor t ance of t he meaning of ‘business’, it is not compr ehensively def ined in UK (or EC) legislat ion. VATA 1994, s 94 gives t he f ollowing guidance as t o what t he t er m encompasses and excludes.
(a) I t includes any t r ade, pr of ession or vocat ion.
(b) The f ollowing (wit hout pr ej udice t o t he gener alit y of anyt hing else in VATA 1994) ar e deemed t o be t he car r ying on of a business.
a. The pr ovision by a club, associat ion or or ganisat ion (f or a subscr ipt ion or ot her consider at ion) of t he f acilit ies or advant ages available t o it s member s (but see (c) below).
b. The admission, f or a consider at ion, of per sons t o any pr emises.
(c) Wher e a per son accept s any of f ice in t he cour se or f ur t her ance of a t r ade, pr of ession or vocat ion, ser vices supplied by him as holder of that of f ice ar e t r eat ed as supplied in t he cour se or f ur t her ance of t hat t r ade, pr of ession or vocat ion.
(d) Anyt hing done in connect ion wit h t he t er minat ion or int ended t er minat ion of a business is treated as being done in the course or furtherance of t hat business.
(e) The disposit ion of a business as a going concer n, or of it s asset s or liabilit ies (whet her or not in connect ion wit h it s r eor ganisat ion or winding up) is a supply made in t he cour se or f ur t her ance of t he business.
When consider ing whet her an act ivit y is t o be t r eat ed as a business, if it is not one of t he deemed businesses above t hen t he ‘business t est ’ must be applied. This t est is derived f rom decisions of t he VAT t r ibunals and Cour t s.
The f ollowing pr inciples, as summar ised in C & E Commr s v Lor d Fisher , ar e a guide as t o whet her an act ivit y is a business alt hough t he absence of one common at t r ibut e of or dinar y businesses (e.g. t he pur suit of pr of it ) does not necessar ily mean t hat t he act ivit y is not a business and t he cr it er ia ar e not t her ef or e conclusive in ever y case.
(a) By pr oviding in VATA 1994, s 94 t hat business includes any t r ade, pr of ession or vocat ion, it is clear t hat a wide meaning of ‘business’ is int ended.
(b) I n det er mining whet her any par t icular act ivit y const it ut es a business it is necessar y t o consider t he whole of t hat act ivit y.
Def init ion of Supplies 447
(c) A business act ivit y can gener ally be ident if ied f r om t he answer s t o t he f ollowing cr it er ia (as laid down in C & E Commr s v Mor r ison’s Academy Boar ding Houses Associat ion).
(i) I s t he act ivit y a ‘ser ious under t aking ear nest ly pur sued’ or a ‘ser ious occupat ion not necessar ily conf ined t o commer cial or pr of it making under t akings’?
(ii) I s t he act ivit y an occupat ion or f unct ion act ively pur sued wit h r easonable or r ecognisable cont inuit y?
A one-of f supply or a ser ies of inf r equent , unconnect ed supplies is not nor mally a business act ivit y in it s own r ight alt hough it is impor t ant t o consider t he nat ur e of t he act ivit y. For example, occasional sales by small speculat ive builder s and pr oper t y developer s ar e business act ivit ies.
(iii) Does t he act ivit y have a cer t ain measur e of subst ance as measur ed by t he quar t er ly or annual value of t axable supplies made?
(iv) I s t he act ivit y conduct ed in a r egular manner and on sound and r ecognised business pr inciples?
(v) I s t he act ivit y pr edominant ly concer ned wit h t he making of t axable supplies t o consumer s f or a consider at ion?
This is per haps t he most impor t ant point t o est ablish, bear ing in mind t hat ‘consider at ion’ need not necessar ily be monet ar y. I f a t r ader is car r ying on an act ivit y which does not involve t he making of any supplies f or a consider at ion and t her e is no int ent ion in t he f ut ur e of doing so, t hen t he act ivit y is unlikely t o be r egar ded as business even if all t he ot her cr it er ia ar e met .
I n C & E Commr s v The Apple and Pear Development Council, [1988]) t he Council’s pr incipal act ivit y was t o adver t ise English apples and pear s, which act ivit y was f inanced by a st at ut or y levy on gr ower s. The CJEC r uled t hat t he levy was not consider at ion because t her e was no dir ect link bet ween t he payment s and t he benef it s of individual gr ower s on which basis t he House of Lor ds concluded t hat t he act ivit y was not ‘business’ in t he VAT sense.
Wher e an act ivit y is j ust beginning and no supplies ar e being made at t he t ime but t her e is a clear int ent ion t o do so at some t ime in t he f ut ur e, t hen t he act ivit y may qualif y as a business. See Rompelman v Minist er van Financien, [1985] and Mer seyside Cablevision Lt d.
448 Principles of Business Taxat ion ‘Finance Act 2006’
(vi) Ar e t he t axable supplies of a kind which ar e commonly made by t hose who seek t o pr of it by t hem?
I f a per son is car r ying on an act ivit y and it is not clear whet her it amount s t o a business, it is mor e likely to be regarded as such if ot her s ar e car r ying on t he same t ype of act ivit y and ar e clear ly doing so on a commer cial basis. I n Chur ch of Scient ology of Calif or nia (No 1) v C & E Commr s, [1981] cour ses in t he st udy of it s belief s provided by t he Church, some of which compet ed wit h t hose of f er ed by t r ained psychologist s and psychiat r ist s, wer e f ound t o be business act ivit ies.
(d) Whet her t he act ivit y is pur sued f or prof it or some ot her pr ivat e pur pose or mot ive is not decisive in det er mining whet her t he act ivit y is a business.
(e) I f all or a suf f icient number of t he above cr it er ia ar e sat isf ied in suf f icient measur e t o over r ide any cont r a-indicat ions which might be seen in t he f act s, t hen as a mat t er of law t he act ivit y must be held t o be a business.
The car r ying on, by a r egulat or y aut hor it y, of a st at ut or y licensing act ivit y t o pr ot ect t he public int er est is not a business act ivit y even t hough car r ied on f or a consider at ion. I n I nst it ut e of Char t er ed Account ant s in England and Wales v C & E Commr s, [1999] t he I nst it ut e’s aut hor isat ion t o issue licences t o audit or s, insolvency pr act it ioner s and per sons car r ying on invest ment business was held not t o be a business act ivit y.
Business Br ief 02/ 2005 pr ovides usef ul r ef er ence t o t he business t est .
E3.7 Taxable Supply
The f inal point is whet her or not t he supply is a t axable supply. Once it has been est ablished t hat t her e is a supply we t hen need t o det er mine whet her t he s.4(2) supply is t axable, exempt or out side t he scope of VAT complet ely.
Taxable will be at one of t hr ee r at es of VAT; t he standard rate, a lower rate and a zero rate. The st andar d r at e is cur r ent ly 17.5%, t he lower r at e is cur r ent ly 5% and t he zer o r at e, as you would expect , is 0%. The legislat ion det ails supplies which ar e at t he lower r at e of 5%, and t he zer o r at e of 0%. The legislat ion also out lines which supplies ar e exempt supplies and, t o a cer t ain ext ent , which supplies ar e out side t he scope of VAT. I f your supply is not wit hin one of t hose specif ic def init ions, t hen t he supply is t axable at 17.5%.
Def init ion of Supplies 449
Supply
Taxable Exempt Out side the scope of VAT
17.5% 5% 0%
St andar d Lower Zer o Rat e Rat e Rat e
So t her e we have it , t he f ive condit ions. For t her e t o be a t axable supply you must meet all f ive.
450 Principles of Business Taxat ion ‘Finance Act 2006’
SUMMARY – DEFINITION OF SUPPLIES
For a supply t o be char ged t o VAT t hat supply must be a supply of goods or ser vices, made by a t axable per son, in t he UK, in t he cour se or f ur t her ance of a business. I n addit ion, t he supply must be a t axable supply and gener ally consider at ion must be pr esent . Consider at ion is not necessar ily cash. The def init ion of consider at ion is payment in money or in kind.
The supply of goods is def ined as a t r ansf er of t he whole pr oper t y in goods. Anyt hing done f or consider at ion which is not a supply of goods is a supply of ser vices.
A t axable per son is a per son who is or should be VAT r egist er ed.
A supply made in t he UK includes supplies made in t he I sle of Man as well as England, Scot land, Wales and Nor t her n I r eland.
A supply made in t he cour se or f ur t her ance of a business r equir es some sor t of economic act ivit y wit h a per son or a company car r ying on a t r ade, pr of ession or vocat ion. A pr of it mot ive is not necessar y.
A t axable supply is a st andar d r at ed or zer o r at ed supply as def ined by t he VAT legislat ion.
E4: LIABILITY OF THE SUPPLY
This chapt er is going t o look at t he f ollowing: how we wor k out whet her a supply is char geable t o VAT; if it is, how much VAT we act ually char ge on t hat supply; - t he t hr ee t ypes of supply; - t he way t o cat egor ise a supply in or der t o wor k out t he cor r ect VAT t r eat ment .
E4.1 Introduction
This chapt er looks at how t o wor k out whet her a supply is char geable t o VAT and, if it is, how much VAT t o char ge on t hat supply. Ef f ect ively, it could be said t hat t her e ar e t hr ee t ypes of supply. The f ir st t ype of supply is a taxable supply which is t he sort of supply t hat VAT will apply t o. The second t ype of supply is an exempt supply – t her e is no VAT on an exempt supply. The f inal t ype of supply is called out side t he scope, t hese supplies ar e complet ely ignor ed when looking at t he VAT legislat ion alt hough we may have t o be car ef ul if input VAT has been paid which t he business would like t o r ecover in r elat ion t o a supply t hat was out side t he scope because such input VAT cannot nor mally be r ecover ed. This will be dealt wit h in a lat er chapt er.
E4.2 Taxable supplies
Basically t her e ar e t hr ee t ypes of t axable supply. The f ir st t ype of t axable supply is called st andar d r at ed because t he st andar d r at e of VAT would apply t o t his supply – so 17.5% VAT will be charged on standard rated taxable supplies.
The second t ype of t axable supply is a supply t axable at t he lower rate of VAT, which is currently standing at 5%.
The f inal t ype of supply t hat is t axable is t he zer o-r at ed t axable supply which, of cour se, is t axable at t he zero rate of VAT – 0% VAT.
I n t he VAT legislat ion t her e is a list of zer o-r at ed supplies in Schedule 8 of t he Value Added Tax Act (VATA) 1994. There is a list of lower r at e supplies in Schedule 7A of VATA 1994. There is a list of exempt supplies in Schedule 9 of Sch 8 VATA 1994. There is some inf ormation in VAT Notice 701/39 on VAT liabilit y Sch 9 law, but nowher e in t he legislat ion is t her e a def init ive list of st andar d r at ed t axable supplies.
E4.3 Method of determining liability
A business supplies widget s. How should it t r eat t hat supply of a good f or VAT pur poses? Fir st ly one looks at Schedule 8 of VATA 1994. Schedule 8 out lines all the zero rated supplies made f or VAT legislat ion pur poses.
452 Principles of Business Taxat ion ‘Finance Act 2006’
I f t he business cannot f ind t he supply list ed in Schedule 8 t he next st ep is t o look at Schedule 9. Schedule 9 list s all t he exempt supplies.
I f t he widget is neit her zer o r at ed nor exempt , t hen st ep t hr ee is t o see if t he Sch 7A supply is subj ect t o VAT a t he lower r at e under Schedule 7A. Ther e ar e
specif ic it ems which ar e char ged t o VAT at t he lower r at e (see below).
The next st ep would be t o decide if t he widget was outside the scope of VAT. Again t her e ar e specif ic supplies t hat ar e out side t he scope of VAT, f or example, t r ansf er r ing a business as a going concer n.
Thus if t he it em is not zer o r at ed, not exempt , not char ged at t he lower r at e and not out side t he scope of VAT t hen what is lef t is a st andar d r at ed t axable supply and t hat is what t he widget must be. This is t he f inal st ep. Ther e is no list of st andar d r at ed t axable supplies in t he legislat ion – basically one get s t here by def ault .
St ep 1 Schedule 8 (zero rated) ↓ ↓ 2 Schedule 9 (exempt) ↓ ↓ 3 Schedule 7A (lower rated) ↓ ↓ 4 Out side t he scope (specif ic supplies) ↓ ↓ 5 St andard Rat ed
Zero rating will always take priority over exempt ion by r eason of s.30(1) VATA 1994. I f an it em could f all int o bot h Schedule 8 and Schedule 9 it will always be zer o r at ed since t his t akes pr ior it y.
E4.4 Lower Rate (5%)
The lower r at e of VAT is cur r ent ly 5% and t he supplies t hat ar e subj ect t o t he lower r at e ar e out lined in Schedule 7A of VATA 1994. The main supply t hat is Sch 7A associat ed wit h t he lower r at e of VAT is supplies of f uel f or domest ic use f or Groups 1, 4 example, gas and elect r icit y supplied t o people’s homes. Also covered by the t o 5 lower r at e is t he supply of ladies sanit ar y pr oduct s, t he supply of childr en’s car seat s and gr ound sour ce heat pumps.
Wher e dwellings ar e being r enovat ed, having been empt y f or at least t hr ee Sch 7A year s or mor e and t hose dwellings ar e basically a single household, t hen t he Group 7 lower r at e of VAT also applies t o t he r enovat ion.
Also on t he list f or lower r at e VAT is t he conver sion of a r esident ial pr oper t y int o a dif f er ent number of dwellings. This would cover , f or example, t he Sch 7A conversion of a house into f lats. By a similar t oken conver t ing a non-r esident ial Group 6 pr oper t y int o a dwelling or a number of dwellings is also a r ecent addit ion t o t he list and an example of t his would be conver t ing a bar n int o a house.
Liabilit y of t he Supply 453
The conversion of a dwelling into a care home or into a house in multiple occupat ion is also at t he lower r at e and conver t ing a car e home int o a single household dwelling or dwellings is also at t he 5% r at e.
These ar e t he main it ems which ar e char ged t o VAT at t he lower r at e – t her e Sch 7A ar e a f ew ot her s cover ed in t he Schedule, f or example, t he ser vices of inst alling Groups 2 & 3 ener gy saving mat er ials int o homes and supplies of inst alling cent r al heat ing or
secur it y equipment int o homes of t he elder ly ar e also cover ed by t he lower r at e.
New f or t his year is t he r educed r at e of 5% will now apply t o sale of all cont r acept ive pr oduct s including sales by r et ailer s, vending machines or via t he int er net . FA2006 int r oduced t he r educed r at e f or cont r acept ives and it will apply f r om 1 J uly 2006.
E4.5 Outside the Scope of VAT
The sor t s of it ems t hat ar e complet ely out side t he scope of VAT ar e t hings like;
VAT Not ice 700 par a 8.14 • st at ut or y char ges;
• salar ies and wages;
• t ips and gr at uit ies given t o st af f ; C&E Manual V1-3 Chapt er • f ees and honor ar ia paid t o cler gymen; 2B Par a .6
• int er -gr oup t r ansact ions if t her e is a VAT gr oup r egist r at ion in f or ce; s.43 and SI 1995/ 1268 • t he sale or pur chase of a business as a going concern.
454 Principles of Business Taxat ion ‘Finance Act 2006’
SUMMARY – LIABILITY OF THE SUPPLY
Ther e ar e t hr ee t ypes of supply: - t axable - exempt - out side of t he scope
Ther e ar e t hr ee t ypes of t axable supply: - st andar d r at ed - lower r at e - zero rated
Schedule 8 of VATA 1994 list s t he zer o r at ed supplies.
Schedule 9 of VATA 1994 list s t he exempt supplies.
Supplies subj ect t o t he lower r at e of VAT ar e out lined in Schedule 7A of VATA 1994.
Cer t ain supplies ar e out side t he scope of VAT, t hese include: t he sale or pur chase of a business of a going concer n int er gr oup t r ansact ions wit hin a VAT gr oup t ips and gr at uit ies salar ies and wages paid t o st af f st at ut or y char ges.
Ther e is no def init ion in t he legislat ion of st andar d r at ed supplies. Ef f ect ively if a supply is not zer o r at ed, is not exempt , is not t axable at t he lower r at e, and is not out side t he scope of VAT, t hen it is by except ion a st andar d r at ed supply.
E5: SCHEDULE 8 VATA 1994 – ZERO RATING
This chapt er will look at t he t ypes of supply list ed as zer o r at ed supplies. Ther e ar e sixt een cat egor ies of zer o r at ed supplies which are list ed in Schedule 8 of VATA 1994.
E5.1 Introduction
Schedule 8 t o t he VAT Act 1994 is simply a list of zer o r at ed it ems. These Sch 8 it ems have been collat ed int o sixt een gr oups.
• Group 1 is f ood • Group 2 is sewer age and wat er • Group 3 is books • Group 4 is t alking books f or t he blind and handicapped and wir eless set s f or t he blind • Group 5 is t he const r uct ion of buildings • Group 6 is pr ot ect ed buildings • Group 7 is int er nat ional ser vices • Group 8 is t r anspor t • Group 9 is car avans and houseboat s • Group 10 is gold • Group 11 is bank not es • Group 12 is dr ugs, medicines and aids f or t he handicapped • Group 13 is impor t s and expor t s • Group 14 is t ax f r ee shops • Group 15 is char it ies • Group 16 is clot hing and f oot wear .
I f any par t icular supply f alls wit hin one of t hese Groups, t hen t hat supply will be zer o r at ed.
This chapt er will look at t he mor e common Groups.
E5.2 Group 1 - Food
Group 1, Schedule 8, VATA 1994 zer o r at es t he supply of f ood.
Ther e ar e however , many except ions t o t he zer o r at ing of f ood.
456 Principles of Business Taxat ion ‘Finance Act 2006’
The main exceptions – foodstuffs
Group 1 list s a number of quit e specif ic except ions wher e t he supply of t he f oodst uf f it self is st andar d r at ed. Examples ar e:
• ice cr eam, ice lollies, f r ozen yoghur t et c.;
• sweet s and chocolat e biscuit s, but not cakes and not “non-chocolat e” biscuit s;
• “bever ages” ot her t han milk, t ea, cocoa and cof f ee, and “meat ext r act s” such as Bovr il;
• “snacks” which ar e made f r om pot at o, “swelled cer eals” (i.e. popcor n) and “nut s ot her t han nut s in shell”.
Ther e ar e cases about t he bor der lines of t he def init ions of t hese it ems, such as whet her a J af f a cake is a chocolat e biscuit or a cake.
Catering
The bigger pr oblem t ends t o be t hat “cat er ing” is a st andar d r at ed ser vice. A “cat er er ” can t her ef or e buy in zer o r at ed ingr edient s f r om supplier s, and t ur n t hem int o a st andar d r at ed supply t o cust omer s. Whet her a supply is cat er ing depends on t he f act s of t he case, but t he f ollowing pr inciples and examples illust r at e t he bor der lines.
“For consumption on the premises”
The law st at es t hat cat er ing includes “any supply [of f ood] f or consumpt ion on t he pr emises on which it is supplied”.
This r aises t wo quest ions:
• what ar e “t he pr emises on which it is supplied”?
• is t her e an expect at ion or int ent ion t hat the food will be consumed on the pr emises?
Clear ly some supplies give no pr oblem. Meals ser ved in r est aur ant s ar e cat er ing; f ood supplied in conj unct ion wit h an event such as a wedding r ecept ion will also be cat er ing.
Many other supplies however do cause problems when trying to define the “pr emises”.
Schedule 8 VATA 1994 – Zero Rat ing 457
“Food plus service”
Cat er ing is nor mally under st ood t o include a supply of “f ood wit h ser vice”, and any ser vices r ender ed in addit ion t o t he basic f ood may lead Cust oms t o ar gue t hat t he supply is st andar d r at ed.
“Hot takeaways”
The law st at es t hat cat er ing also includes hot f ood t o be eat en of f t he pr emises, wher e t he f ood “has been heat ed f or t he pur poses of enabling it t o be consumed at a t emper at ur e above t he ambient air t emper at ur e”, and it is above t hat t emper at ur e when it is supplied (see Not e 3 of Group 1).
The issue her e is whet her t he f ood has been heat ed f or t he pur pose of enabling t o be eat en hot , or mer ely t o make it edible (i.e. cooked, not r aw) or t o make f r esh f ood available in t he shop. This has t o be decided on t he f act s, but it depends lar gely on t he expect at ions of t he vendor . For example, whole chickens sold hot wer e unlikely t o be eat en immediat ely (Nicola Holmes t / a The Chicken Shop); but a t rader who admit t ed t hat “f illed cr oissant s” wer e unpalat able once they were cold was held to be catering (Pret a Manger (Eur ope) Lt d). A baker who baked pies and sold t hem shor t ly af t er war ds was held t o be cr eat ing “f r esh pies” which might be eat en hot or cold (J ohn Pimblet t & Sons Lt d v C & E); but a home deliver ed cur r y was expect ed t o be eat en hot (M A Malik v C & E).
The Appeal body recently found in favour of Customs in an appeal by Domino’s Pizza Group Lt d, who had ar gued t hat t heir supplies of hot t akeaway and deliver ed pizzas should be zer o-r at ed because t heir pur pose in heat ing t he goods is t o supply a f r eshly baked pr oduct , r at her t han t o enable t heir cust omer s t o consume t he pr oduct hot . However , in t he j oined cases of Tuscan Food Lt d and Pur e At ma Lt d No. 18,716 t he Appeal body accept ed t hat “Toast y” sandwiches wer e t oast ed not so t hat t hey could be eat en hot , but so t hat t he f lavour of t he f illings wer e enhanced.
The Value Added Tax (Food) Order 2004 came int o f or ce on 1.1.05 and amends Group 1 Sch 8 VATA 1994 not e (3) t o conf irm t hat t he t ime at which t he t emper at ur e of t he f ood is r elevant f or det er mining whet her it is hot f ood is t he t ime t he f ood is pr ovided t o t he cust omer , r at her t han t he t ime of supply as det er mined under ot her pr ovisions of VATA 1994 (the most relevant of which f or pr esent pur poses is t he t ime at which t he supplier r eceives payment ).
The pur pose of t he or der is t o r emove any possible uncer t aint y and conf ir m t hat supplies of hot t akeaway f ood ar e st andar d-r at ed ir r espect ive of t he t iming of payment .
Usef ul guidance is also given in Business Brief 09/05
458 Principles of Business Taxat ion ‘Finance Act 2006’
I n conclusion, f ood will gener ally be zer o r at ed unless t he f ood it self is except ed f r om zer o r at ing or it is supplied in t he cour se of cat er ing.
E5.3 Group 3 - Books
Under t his gr ouping zer o r at ing cover s books, br ochur es, pamphlet s, leaf let s, newspaper s, j our nals and per iodicals, childr en’s pict ur e books and paint ing books, any pr int ed music mat t er and maps.
Whilst zer o r at ing cover s t he har d copies of t he above, any elect r onic t r ansmission of such books would not f all wit hin t he zer o r at ing pr ovisions. This was pr oven t o be t he case in For exia UK Limit ed and Cust oms have announced t hat t hey see no r eason f or t he VAT legislat ion t o be updat ed t o include elect r onic books.
Talking books f or t he blind and handicapped and wir eless set s f or t he blind will also be zer o r at ed.
E5.4 Group 5 - Construction of Buildings
The zer o r at ing of pr oper t y is a maj or ar ea t o look at and t her e is a separ at e session on t his par t icular gr ouping lat er in t he t ext . For now, we will j ust int r oduce t he zer o r at ing pr ovision. When consider ing t he const r uct ion of a building and t he zer o r at ing of t he onwar d supply you need t wo t hings; t he r ight t ype of supply and t he r ight t ype of building. You must have both. I f both are pr esent t hen t he supply will be zer o r at ed.
As r egar ds t he r ight t ype of supply, it must be t he f ir st gr ant of a maj or int er est in t hat building. A maj or int er est f or t hese pur poses will be a f r eehold s.96(1) or a lease exceeding 21 year s. So, f or example, t he builder would have t o sell t he f r eehold in a pr oper t y or gr ant a 25 year lease.
As r egar ds t he r ight t ype of building, t her e ar e only t hr ee t ypes of buildings which f all wit hin t he zer o r at ing pr ovisions; • a dwelling would f all wit hin t his cat egor y; • a r elevant r esident ial building would also f all wit hin t he cat egor y; and, • a r elevant char it able building.
Relevant residential buildings ar e def ined in t he legislat ion and would include dr ug r ehabilit at ion cent r es, school dor mit or ies, monast er ies, nunner ies – t her e is a def ined list of r elevant r esident ial buildings in Not e 4 of Group 5. However , a charit able building is a building used by a charit y f or a charitable purpose.
To summarise t his grouping t hen, if a builder built a house and sold t he f r eehold of t he house he has t he r ight t ype of supply, t he f r eehold, he also has t he r ight t ype of building; he would t her ef ore zer o r at e t he f r eehold sale.
Schedule 8 VATA 1994 – Zero Rat ing 459
At t his point j ust not e t hat t his gr ouping also includes t he supply of ser vices and r elat ed mat er ials in t he const r uct ion of dwellings – but mor e on t his in a lat er chapt er .
Group 6 pr ovides zer o r at ing t o cer t ain aspect s of list ed buildings or protected buildings.
E5.5 Group 15 - Charities
Zer o-r at ed under t his gr oup ar e:
• Goods donat ed or hir ed t o a char it y f or sale or hire by t he charit y.
• Sale or hire by a charit y of goods which have been donat ed or hir ed t o t he char it y. This includes supplies int o t he char it y and t hen supplies f rom t he charit y.
• Any adver t ising supplied t o a char it y.
• Repair and maint enance of r elevant goods owned by an eligible body (Not e 4)
Relevant goods ar e list ed in t he VAT legislat ion (Not e 3) and ar e mainly connect ed wit h t he medical indust r y. Eligible bodies ar e also pr imar ily healt h based.
Char it ies ar e cover ed in det ail in Chapt er 36 of t his manual.
E5.6 Group 16 - Clothing and Footwear
Ar t icles designed as clot hing or f oot wear f or childr en and not suit able f or older per sons, will at t r act zer o r at ing. Ar t icles of clot hing will include hat s, and ot her f or ms of headgear .
Prot ect ive boot s and helmet s f or indust r ial use unless t he supply is made t o an employer f or his employee’s use can be zer o r at ed. These boot s and helmet s must be BSI st andar d.
Prot ect ive helmet s f or mot or cyclist s and pedal cyclist s again t o BSI st andar d can be zer o r at ed.
E5.7 A word of warning
When consider ing t he it ems wit hin t hese Groups, it is impor t ant t hat you f ully r ead all t he not es at t ached t o t he Groups (including t he small pr int at t he end of each Group) wit hin t he legislat ion or t he VAT Not ice.
460 Principles of Business Taxat ion ‘Finance Act 2006’
Example 1
Using t he legislat ion, or t he VAT Not ice, decide which of t he f ollowing ar e zer o r at ed.
• A child’s paint ing book
• Sandwiches sold and consumed in a caf é
• Baby’s nappies
• A packet of her bal t ea sold by a gr ocer
• Chocolat e biscuit s sold by a gr ocer
• Coach j our ney f r om London t o Edinbur gh
• Child’s sheepskin gloves
Schedule 8 VATA 1994 – Zero Rat ing 461
Answer 1
• A child’s paint ing book will be zer o r at ed by means of Schedule 8 Group 3 I t em 3.
• Sandwiches sold in t he caf é will be st andard rat ed; t hey do not f all wit hin t he zer o r at ing pr ovision of Schedule 8 Group 1 because t hey ar e supplied in t he cour se of cat er ing.
• Babies’ nappies will be zer o r at ed under Schedule 8 Group 16 I t em 1.
• The packet of herbal tea sold by a grocer will be zero rated by means of Schedule 8 Group 1. Tea is f ood f it f or human consumpt ion; it is wit hin t he except ed it ems under ot her bever ages but t he it ems over r iding t he exceptions, in this case I tem 4, further down in t he legislat ion, specif ically st at e t hat her bal t ea over r ides any except ions t o t his Schedule, t her ef or e t he her bal t ea sold by a gr ocer is zer o r at ed. This is a good example of why it is so impor t ant t o r ead all of t he not es in each Group.
• Chocolat e biscuit s sold by a gr ocer will not be zer o r at ed; t hey ar e deemed to be a luxury good i.e. not an essent ial good and ar e excluded f r om zer o r at ing by way of Schedule 8 Group 1 except ed I t em 2.
• A coach j our ney f r om London t o Edinbur gh will be zer o r at ed by means of t he t r anspor t zer o r at ed gr oup at Schedule 8 Group 8.
• A child’s sheepskin gloves will be zer o r at ed by means of Schedule 8 Group 16 Item 1. Note that articles designed as clothing or footwear for young childr en will be zer o r at ed and alt hough t her e is an except ion wher eby ar t icles ar e made of f ur skin, t his would not apply in t his inst ance, as sheepskin is not deemed t o be f ur skin under Not e 3 of Group 16.
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SUMMARY – SCHEDULE 8 VATA 1994 – ZERO RATING
Schedule 8 of VATA 1994 list s t he t ype of supplies which f all int o zer o r at ing f or VAT pur poses. Ther e ar e ef f ect ively sixt een gr oups of such supplies which include:
- f ood - books - const r uct ion of buildings - t r anspor t - clot hing and f oot wear f or childr en
I t is impor t ant when looking at it ems list ed wit hin t he gr oups in Schedule 8 t hat you r ead all t he not es at t ached t o t hose gr oups because many except ions t o t he gener al r ule lie wit hin t hose not es.
E6: SCHEDULE 9 VATA 1994 - EXEMPTIONS
I n t his chapt er t he supplies which ar e exempt f or VAT will be looked at in some det ail.
E6.1 Introduction
I n t his chapt er we ar e j ust going t o have a br ief look at Schedule 9 - Exempt ion. Schedule 9 t o t he VAT Act of 1994 pr ovides a list of exempt it ems. Essent ially Sch 9 t hese ar e 15 gr oups and each gr oup is a specif ic exempt ion.
Group 1 - Land 2 - I nsur ance 3 - Post al Ser vices 4 - Bet t ing, Gaming and Lot t er ies 5 - Finance 6 - Educat ion 7 - Health and Welfare 8 - Bur ial and Cremat ion 9 - Tr ade Unions and Prof essional Bodies 10 - Spor t , Spor t s Compet it ions and Physical Educat ion 11 - Works of Art, etc 12 - Fund r aising event s by Char it ies and ot her qualif ying bodies 13 - Cult ur al Ser vices etc 14 - Supplies of goods wher e input t ax cannot be deduct ed 15 - I nvest ment Gold
E6.2 Group 1 - Land
The exempt ion f or land will be cover ed in det ail lat er in t he t ext . For now, we ar e going t o pr ovide an over view of t he exempt ion f or land. Schedule 9 st at es t hat any land t r ansact ion is exempt other than t he it ems act ually list ed in t he legislat ion. So t he legislat ion ef f ect ively says t hat any land t r ansact ion (e.g. lease, r ent , sale, assignment , sur r ender , r ever se sur r ender , r ever se pr emium) is exempt ot her t han t he it ems it list s which is a list of st andar d r at ed it ems (Schedule 9 it em 1 (a) t o (m)).
I n t he list of st andar d r at ed it ems t he most impor t ant will be it em 1(a) which cover s t he supply of a new, f r eehold commer cial building. So a sale of a new f r eehold commer cial pr oper t y is st andar d r at ed. New is deemed t o be under 3 year s old (Schedule 9, Group 1, Not e 4).
464 Principles of Business Taxat ion ‘Finance Act 2006’
Also in t his long list ar e t hings like hot el accommodat ion, t heat r e and concer t t icket s, camping and car avan sit es and car par k char ges.
Finally f or complet eness, an opt ion t o t ax is available which will change an exempt supply of land int o a t axable supply. The opt ion t o t ax can only apply t o land or commer cial pr oper t y. Remember t his is an over view of t he land Sch 10 exempt ions and t hese, plus t he opt ion t o t ax, will be cover ed in much mor e det ail in a lat er chapt er .
E6.3 Insurance
VATA 1994 Sch.9 Group 2 exempt s t he pr ovision of :
• it em 1: insur ance t r ansact ions and r einsur ance t r ansact ions;
• it em 4: t he pr ovision by an insur ance br oker or insur ance agent of any of t he ser vices of an insur ance int er mediar y in a case in which t hose ser vices ar e r elat ed t o an insur ance t r ansact ion or a r einsur ance t r ansact ion (whet her or not t he cont r act is act ually concluded) and t he agent or br oker is act ing in an int er mediar y capacit y.
The not es t o Group 2 descr ibe in some det ail what is t o be r egar ded as “act ing in an int er mediar y capacit y”.
E6.4 Finance
VATA 1994 Sch.9 Group 5 exempt s (among ot her t hings):
• it em 1: t he issue, t r ansf er or r eceipt of , or any dealing wit h, money, any secur it y f or money or any not e or or der f or t he payment of money.
• it em 2: t he making of any advance or t he gr ant ing of any credit .
• it em 2A: t he management of cr edit by t he per son gr ant ing it .
• it em 3: t he provision of t he f acilit y of inst alment cr edit f inance in a hir e-pur chase, condit ional sale or cr edit sale agr eement f or which f acility a separate charge is made and disclosed t o t he r ecipient of t he supply of goods.
• it em 5: t he pr ovision of int er mediar y ser vices in r elat ion t o any transaction comprised in item 1, 2, 3, 4 or 6 (whether or not any such t r ansact ion is f inally concluded) by a per son act ing in an int er mediar y capacit y.
• it em 6: t he issue, t r ansf er or r eceipt of , or any dealing wit h, any secur it y or secondar y secur it y being:
(a) shar es, st ocks, bonds, not es (ot her t han pr omissor y not es), debent ur es, debent ur e st ock or shar es in an oil r oyalt y; or
Schedule 9 VATA 1994 – Exempt ions 465
(b) any document r elat ing t o money, in any cur r ency, which has been deposit ed wit h t he issuer or some ot her per son, being a document which r ecognises an obligat ion t o pay a st at ed amount t o bear er or t o or der , wit h or wit hout int er est , and being a document by t he delivery of which, wit h or wit hout endor sement , t he r ight t o r eceive t hat st at ed amount , wit h or wit hout int er est , is t r ansf er able; or
(c) any bill, not e or ot her obligat ion of t he Tr easur y or of a Gover nment in any par t of t he wor ld, being a document by t he delivery of which, wit h or wit hout endor sement , t it le is t r ansf er able, and not being an obligat ion which is or has been legal t ender in any par t of t he wor ld; or
(d) any let t er of allot ment or r ight s, any war r ant conf er r ing an opt ion t o acquir e a secur it y included in t his it em, any r enounceable or scr ip cer t if icat es, r ight s coupons, coupons r epr esent ing dividends or int er est on such a secur it y, bond mandat es or ot her document s conf er r ing or cont aining evidence of t it le t o or r ight s in r espect of such a secur it y; or
(e) unit s or ot her document s conf er r ing r ight s under any t r ust est ablished f or t he pur pose, or having t he ef f ect of pr oviding, f or per sons having f unds available f or invest ment , f acilit ies f or t he par t icipat ion by t hem as benef iciar ies under t he t r ust , in any pr of it s or income ar ising f rom t he acquisit ion, holding, management or disposal of any pr oper t y what soever .
The notes to Group 5 describe in some detail what is to be regarded as “int er mediar y ser vices”.
Issue of shares
Comment on Kretztechnik
Cust oms have comment ed f ur t her on t he decision in Kr et zt echnik in Business Br ief 21/ 05 (expanding on t he ear lier guidance given in Business Br ief 12/ 05).
Cust oms now accept t hat t he pr inciples of Kr et zt echnik apply t o issues of all t ypes of shar es, including pr ef er ence shar es, r ight s issues, bonus issues (alt hough t hey do not r aise money!) or scr ip dividends.
Cust oms also accept t hat t he pr inciples of t he case apply t o issues of shar es by dif f er ent t ypes of company, and ar e not r est r ict ed t o public quot ed companies such as Kret zt echnik it self . As long as t he company’s pur pose is t o r aise capit al, t he issue of t he shar es will be a non-supply.
466 Principles of Business Taxat ion ‘Finance Act 2006’
This is f ur t her ext ended t o t he issue of ot her t ypes of inst r ument (e.g. bonds, debent ur es, loan not es) wher e t he pur pose is t o r aise capit al. The issue of shar es or unit s in collect ive invest ment f unds (e.g. OEI Cs) will be non-supplies f or VAT pur poses (which is not immediat ely obvious, because t he f unds ar e r aised f or invest ment pur poses r at her t han use in a t r ade; but t he invest ment pur pose is t he business of t he collect ive invest ment scheme, so t he f unds ar e r aised f or t he gener al pur poses of t he business).
Cust oms also accept t hat t he non-supply t r eat ment is cor r ect wher e shar es ar e issued in ot her cir cumst ances, f or example as par t of a shar e-f or -shar e t akeover of anot her company, a mer ger , demer ger or r eor ganisat ion.
Cust oms give t he usual advice about making claims f or past input VAT, subj ect t o t he t hr ee-year cap.
E6.5 Health & Welfare
Ther e ar e a f ew key issues wit hin t he healt h and welf ar e exempt ion, in par t icular :
• t he scope of t he medical car e exempt ion, which was disput ed in t he case of Dr d’Ambr umenil and is cur r ent ly t he subj ect of a consult at ion exercise;
• t he scope of t he welf ar e exempt ion, which was disput ed in t he case of Kingscr est Associat es and which now seems t o be set t led;
• t he t r eat ment of dr ugs pr escr ibed and administ er ed by doct or s, which was consider ed by t he House of Lor ds in t he case of Dr Beynon and par t ner s.
E6.6 Other exempt items
Group 3 – postal services. Cur r ent ly only t he post al ser vices pr ovided by t he Post Of f ice ar e exempt . Businesses which char ge cust omer s post age must add on this charge before calculating the VAT due on t heir invoices. Consequent ly VAT is char ged on post age and car r iage char ges levied by or dinar y businesses.
Group 4 – betting, gaming and lotteries. Alt hough bet t ing dut y has been abolished t he r evenue f r om t hose sour ces will cont inue t o be exempt f or VAT pur poses.
Group 6 – education. Educat ion, r esear ch and vocat ional t r aining supplied by r ecognised bodies such as schools, colleges and univer sit ies will be exempt f r om VAT.
Group 8 – burial and cremation. Ser vices pr ovided in connect ion wit h bur ial and cr emat ion, such as under t aker s’ ser vices ar e exempt f r om VAT.
Group 9 – trade unions and professional bodies. Member ship subscr ipt ions t o t r ade unions and ot her pr of essional bodies ar e exempt .
Schedule 9 VATA 1994 – Exempt ions 467
Group 10 – sport, sports competitions and physical education. The char ge f or ent er ing compet it ions and playing member s subscr ipt ions ar e exempt f r om VAT for non-profit making bodies. Consequent ly subscr ipt ions of non-playing member s of spor t s clubs, such as social member s ar e subj ect t o VAT at t he st andar d r at e.
The House of Lor ds has r ef used t he t axpayer leave t o appeal in t he Messenger Leisur e case. This conf ir ms t he decisions of t he Tr ibunal, High Cour t and Cour t of Appeal t hat a subsidiar y company in a commer cial gr oup could not qualif y as a “not -f or -pr of it ” spor t s club simply because it s const it ut ion rest rict ed it s abilit y t o dist r ibut e pr of it s. The Cour t of Appeal held t hat t he accumulat ion of r eser ves in t he subsidiar y was an act ual commer cial advant age t o t he gr oup, and it was also possible f or t he shar eholder s (t he commer cial holding company) t o change t he const it ut ion and allow distr ibut ion of pr of it in t he f ut ur e.
The Lor ds held t hat t her e was not hing in t he case t o war r ant an ECJ r ef er ence: t he applicat ion of EU law was so obvious t hat t her e was no r oom f or r easonable doubt .
Cust oms have comment ed on t he implicat ions of t his f inal det er minat ion in a Business Business Br ief . They consider t hat t her e ar e numer ous ot her companies which Brief 22/ 05 may be af f ect ed, and t hey believe t hat t he decision conf irms t hat it is impossible f or a company wit hin a commer cial gr oup t o qualif y f or t he exempt ion.
I t is int er est ing t hat Cust oms explicit ly comment about t he f act t hat t he evidence of t he chief t axpayer wit ness on t he mot ives of t he company was unchallenged in t his case. He said that he was not int er est ed in ext r act ing pr of it f r om t he subsidiar y, and Cust oms did not at t empt t o cont r adict him, because t hey did not need t o. The t axpayer ’s case was lost because of t he cor por at e st r uct ur e in any case. I f a dif f er ent st r uct ur e exist s, and t he t axpayer asser t s t hat t her e is no pr of it mot ive, Cust oms will not accept t his wit hout challenge.
Group 11 – works of art et c. The sale of works of art , antiques and collect ors it ems, which ar e not subj ect t o a st at e dut y or inher it ance t ax, ar e exempt .
Group 12 – fund raising events by charities and other qualifying bodies. The ent r ance f ees t o event s such as annual (or mor e f r equent ) f und r aising event s or ganised by char it ies f or t he benef it of t he char it y ar e exempt .
Group 13 – cultural services. Ent r ance f ees t o museums, ar t galler ies, ar t exhibit ions and zoos ar e exempt .
Cult ural services can be provided wit hin t he exempt ion of Sch.9 Group 13 if t hey ar e supplied by a not -f or -pr of it body which is managed on an essent ially volunt ar y basis. This means t hat t hose involved in management should not have any signif icant int er est in t he act ivit ies of t he body. I n a r ecent case a company was f or med in 2000 t o st age oper at ic per f or mances (t aking over an act ivit y which had been r un on an uncommer cial basis since 1991
468 Principles of Business Taxat ion ‘Finance Act 2006’
wit hin t he oper at ions of a commer cial company). I t ar gued t hat it was wit hin t he exempt ion, being limit ed by guar ant ee and managed by a boar d of t r ust ees on a non-commer cial basis. I t s memor andum of associat ion f or bade t he payment of r emuner at ion t o dir ect or s f or act ing as such, but per mit t ed t he payment of interest on loans, rent on premises or fees for professional services to any of t he dir ect or s in appr opr iat e cir cumst ances, as well as t he r eimbur sement of out - of -pocket expenses.
The Tr ibunal agr eed wit h Cust oms t hat t he exempt ion did not apply. One of t he t r ust ees was t he landlor d of t he oper a company, and also was t he sole dir ect or and maj or it y shar eholder of a commer cial company which had f inancial dealings wit h it . He had also made loans t o t he oper a company and guar ant eed it s losses. He t her ef or e had a signif icant f inancial int er est in t he act ivit ies, and he was a signif icant member of t he management . The management was t her ef or e not “essent ially volunt ar y”.
The High Cour t j udge disagr eed. He held t hat t he abilit y of t he company t o cont r act wit h t he dir ect or , wher e no such cont r act was act ually ent er ed int o, did not const it ut e a f inancial int er est . Even if such a cont r act was ent er ed int o, if it was f or necessar y ser vices at t he best pr ice available, t her e would be no dilut ion of the prof its of the entity and the exempt ion would not be pr ej udiced.
I n summar y, t he j udge consider ed t hat “f inancial int er est ” suggest ed t hat t he per son wit h such an int er est could be enr iched by t he ar r angement , and t hat was not t he case her e. The main condit ion was a pr ohibit ion on t he dist r ibut ion of pr of it s, and t hat was sat isf ied. The f act that contracts f or supplies could be ent er ed int o did not disqualif y t he body f r om t he exempt ion; t his depended on t he t er ms of t he cont r act s, not t heir mer e possibilit y. I nt er est -f r ee loans and unenf or ceable guar ant ees also did not const it ut e a f inancial int er est . The appeal was allowed.
High Cour t : Longbor ough Fest ival Oper a v HMRC
Group 14 – supplies of goods wher e input t ax cannot be r ecover ed. This gr oup pr event s double t axat ion on goods wher e input t ax cannot be r ecover ed, such as t he pur chase of a car used f or bot h business and pr ivat e pur poses. Any subsequent sale in t hese cir cumst ances will be exempt .
Group 15 – invest ment gold. This exempt ion pr ovides a r out e f or t he cr eat ion of a st ock of invest ment gold t o be t r aded wit hin an exempt mar ket .
E6.7 A wor d of war ning
I t should be appr eciat ed t hat if a t r ansact ion f alls specif ically wit hin one of t he gr oups list ed in Schedule 9 t hen it will be exempt. Ther e is however , a lot of det ail in t hese gr oups wit hin t he legislat ion, and you must r ead f ully t he legislat ion and t he not es t o t he legislat ion t o det er mine whet her or not your par t icular t r ansact ion is act ually exempt . I f it does not f all wit hin t he zero-rated Schedule 8 or t he exempt Schedule 9 t hen t he t r ansact ion will nor mally be st andar d r at ed.
Schedule 9 VATA 1994 – Exempt ions 469
SUMMARY – SCHEDULE 9 VATA 1994 - EXEMPTIONS
Ther e ar e f if t een gr oups of supplies which are list ed in Schedule 9 of VATA 1994 as exempt supplies. Exempt supplies include:
- land - insur ance - f inance - healt h and welf ar e - bur ial and cr emat ion - f undr aising event s by char it ies
I t is cr ucial t hat t he legislat ion is looked at closely when det er mining if a supply is exempt or not as many except ions t o t he gener al r ule ar e out lined in t he not es t o each of t he gr oups.
E7: DEEMED SUPPLIES
This chapt er looks at deemed supplies and self-supplies. By t he end of t he chapt er you should be able t o: account f or VAT on deemed and self -supplies; be awar e of how t o t r eat a gif t of goods; under st and t he t r eat ment wher e t her e is pr ivat e use of asset s or mot or f uel is pr ovided f or pr ivat e use; out line t he t r eat ment of non-business use of ser vices supplied t o a business out line t he t r eat ment of goods held on de-r egist r at ion of a business; under st and t he t r eat ment of const r uct ion ser vices pr ovided f or own use by a business; out line t he VAT t r eat ment of mot or car s used in a business.
E7.1 Introduction
Deemed supplies and self -supplies ar e in exist ence basically as an ant i-avoidance st r at egy. This ant i-avoidance legislat ion r equir es a t r ader t o account for output tax even though there is no regular supply; in ot her wor ds, even t hough t her e is no supply f or consider at ion t o a t hir d par t y. The ant i-avoidance legislat ion ef f ect ively cover s t wo t ypes of avoidance. The f ir st t ype is wher e a t axable business buys somet hing, r ecover s t he input t ax, and t hen put s t hose it ems t o a non-business use. I f t hose it ems had been bought f or a non-business use in t he f ir st place, input t ax would not have been r ecover able. This is t he deemed supply legislation.
The second scenario is to do with partially exempt and exempt businesses, so businesses t hat make exempt supplies and cannot r ecover input t ax in f ull. I t is t o pr event such businesses f r om get t ing a f ull input t ax recovery t hat t hey would not nor mally achieve. This is t he self-supply legislation.
E7.2 Deemed supplies
Examples of deemed supplies include goods and services bought for business Sch 4 Par a 5 purposes but then supplied free for private consumption. The input t ax or iginally claimed on t he pur chase is clawed back using an out put t ax char ge.
Wher e pet r ol or diesel f or mot or car s is pur chased by a business but t hen s.56 supplied t o t he employee of t hat business at a pr ice t hat is below cost t her e is a
deemed supply and out put t ax is char ged on t he supply using a f ixed st andar d
scale. We will look at t his in mor e det ail lat er .
Anot her example is wher e a business is r egist er ed f or VAT but is now going t o Sch 4 der egist er . Any goods held by t he business on der egist r at ion ar e t r eat ed as Par a 8 deemed supplies if t hose goods had input t ax r ecover ed on t heir pur chase.
Deemed Supplies 471
E7.3 Self-supplies
Self -supplies oper at e in a ver y similar way t o deemed supplies. The self -supply legislat ion basically ensur es t hat t her e is no VAT saving in a sit uat ion wher e input t ax should have been ir r ecover able.
I n cer t ain cases wher e construction services ar e car r ied out in-house, a self - SI 1989/ 472 supply will ar ise wit h output tax charged on open market value.
Anot her scenar io wher e we have a self -supply is when car s ar e pur chased f or 100% business use, but used pr ivat ely. Let us say a car dealer buys br and new car s which he plans t o sell t o t he public, but lat er put s one of t hose car s t o SI 1992/ 3122 pr ivat e use. One of t hose cars is t hus t aken out of st ock and used by an Art 5 employee. This would be a self -supply and t her e is an output tax charge on the cost of the car.
E7.4 How to account for deemed/self-supplies
A business t hat makes a deemed or a self -supply will have t o account f or out put t ax on t he supply, so t her e will be out put t ax t o put in box 1 of t he VAT Ret ur n. This amount will have t o be paid t o Cust oms when t he VAT Ret ur n is submit t ed.
This self-supply or deemed supply counts towards the registration limit when looking at whet her a business should r egist er f or VAT or not .
Deemed supplies will only be in point if t he t rader has r ecover ed input t ax on t he goods or ser vices in quest ion.
When account ing f or out put t ax on a self supply, input t ax is available f or cr edit . This input t ax can only be r ecover ed t o t he ext ent t hat t he it em is t o be used f or making t axable supplies and is not it self subj ect t o t he blocking order.
The deemed and self -supply r ules apply t o all businesses, whet her t axable or exempt. It is quite possible to have a f ully t axable business pr ovide some in- house const r uct ion ser vices. The impact of t his would be t wo ent r ies, equal and opposit e, on t he VAT r et ur n – out put t ax in t he out put t ax box equalling t he amount of input t ax in t he input t ax box. Over all t her e is a nil impact on t he business. Having said t hat , t he business cannot omit t he ent ries f rom t he VAT r et ur n because ot her wise it will have made an incor r ect VAT r et ur n.
E7.5 Gift of goods (deemed supply)
I nput t ax is clawed back on goods t hat ar e given away by making an out put t ax char ge on t he r eplacement cost of such goods. The legislat ion says t hat out put t ax should be char ged wher e goods f or ming par t of t he asset s of a business ar e Sch 4 t r ansf er r ed or disposed of by or under t he dir ect ions of t he per son car r ying on Par a 5 t he business so as no longer t o f or m par t of t hose asset s whet her or not f or a consider at ion.
472 Principles of Business Taxat ion ‘Finance Act 2006’
I t is impor t ant t o appr eciat e t hat t he r ules will not apply unless t he donor (or any of his pr edecessor s) has or will become ent it led t o input t ax r ecover y on t he goods.
For t his pur pose, a per son is t he ‘pr edecessor’ of t he donor wher e t he donor acquir ed t he goods f r om him under a t r ansact ion r elat ing t o t he t r ansf er of a business as a going concer n which was t r eat ed as neit her a supply of goods nor a Sch 4 supply or ser vices. The donor ’s pr edecessor s include t he pr edecessor s of his Para 5(5)(5A) pr edecessor t hr ough any number of t r ansactions. The ef f ect of t his is t hat , f or no VAT liabilit y t o ar ise, no ent it lement t o input t ax on t he goods must have ar isen t hr ough any number of such going concer n t r ansact ions.
However even wher e input t ax is r ecover ed t he gif t may st ill be exempt f r om t his legislat ion. The f ir st exempt ion is wher e t her e is a gif t of goods made in t he cour se or f ur t her ance of t he business wher e t he cost to the donor is not Sch 4 more than £50. The exempt ion applies t o one-of f gif t s and t he cost t o t he Par a 5(2)a donor could also include t he cost of pr oducing t he goods if t hey ar e pr oduced int er nally.
No out put t ax will be due on a ser ies of gif t s pr ovided the total cost of gif ts made t o t he same per son does not exceed £ 50 in any 12 mont h per iod. I f t he £ 50 is exceeded VAT will be due on all t he gif t s made in t he pr evious 12 mont hs. Those gif t s ar e t hen disr egar ded f or t he pur pose of any f ut ur e applicat ion of t he r ules.
The ot her sit uat ion wher e t he r ules do not apply is wher e t her e is a gift to any person of a sample of any goods. This applies only t o t he f ir st gif t wher e a Sch 4 succession of ident ical samples is given t o t he same per son. Ther e is no Par a 5(2)B monet ar y value on t hese sample gif t s eit her .
So t o summarise, wit h a gif t of goods which cost £ 50 or less, t hen one needs t o look at what t he mot ive f or t he gif t was. I f t he mot ive was a business pur pose t hen t he gif t is ignor ed and does not t r igger an out put t ax char ge and any input t ax r eclaimed by t he business is allowed. I f t he gif t of goods cost s over £ 50 (can be cumulat ive) t hen input t ax will ef f ect ively be clawed back as an out put t ax char ge unless it is t he gif t of a business sample.
E7.6 Private use of business assets (deemed supply)
Consider t he scenar io of inst ead giving someone an asset f or t heir pr ivat e use, t he asset was j ust made available f or t hem t o use pr ivat ely but t he owner ship r emained wit h t he VAT r egist er ed business. The r ules on gif t s of goods do not
apply wher e an asset is only made available f or pr ivat e use wit hout char ge but
r emains par t of t he asset s of t he business. S.24(5) Or dinar ily wher e goods or ser vice ar e acquir ed wit h t he expectat ion of some non
business use, t he t r ader will appor tion t he init ial input t ax r ecover y. Sch 4 Par a 5(4)
Deemed Supplies 473
The appor t ionment pr ovisions of s.24(5) wer e quest ioned in t he case of Lennar t z. Lennar t z adopt s a dif f er ent appr oach by ensur ing a f ull input r eclaim f ollowed by an out put t ax char ge in ever y VAT quar t er in which pr ivat e use t akes place wit h t hat out put t ax char ge r ef lect ing t he cost of pr oviding t hat asset f or pr ivat e use.
Thus t he Lennartz r ule allows pur chaser s of goods which ar e t o be used bot h f or business and pr ivat e (or non business pur poses) t o r ecover t he VAT in f ull on t he pur chase of t he it em and t hen char ge out put t ax on t he mar ket value of t he non business and pr ivat e use as it ar ises.
I f a car is pr ovided f or t he pr ivat e use of an employee, no supply act ually ar ises whet her or not t he employee makes an act ual payment f or t he pr ivat e use. This SI 1992/ 3222 seems a ver y odd r ule but t his r ule has come about because some or all of t he Par a 7(1) input t ax on t he car has been blocked in t he employer ’s hands.
I f a mobile phone is pr ovided t her e ar e some ver y complex r ules which ar e out lined in Business Br ief 14/99. Ef f ect ively a business can deduct all t he input t ax on t he init ial pr ovision of t he mobile phone pr oviding t he payment s cont ain no element f or calls which might be used f or pr ivat e pur poses and obviously as long as t her e is some business use. I f t he business pr ohibit s pr ivat e use of t he phone t hen all t he input t ax will be deduct ible. I f t he business char ges employees f or pr ivat e calls made t hen again all input t ax is deduct ible but t he business must account f or out put t ax on t he char ges. I f t he business allows employees t o make pr ivat e calls wit hout char ge, t hen t he business has got t o appor t ion t he input t ax on t he call char ges and only claim t he business pr opor t ion.
Illustration 1
ABC Limit ed own a hor se used f or business pur poses 40 days per quar t er and f or pr ivat e pur poses by t he company employees 30 days per quar t er .
Cost s associat ed wit h keeping t he hor se ar e:
St able f ees per annum £ 5,000 Vet s bills, liver y f ees et c per annum £ 1,000 Use of t r ekking f acilit ies in quar t er : - business days £ 400 - pr ivat e days £ 300
474 Principles of Business Taxat ion ‘Finance Act 2006’
We have to work out the private cost of keeping t he hor se. That will be our deemed supply f or one quar t er .
Deemed supply f or one quar t er : £
St able f ees £ 5,000 x ¼ x 30/ 70 536.00
Vet et c f ees £ 1,000 x ¼ x 30/ 70 107.00
Tr ekking f ees – pr ivat e days 300.00
Cost of pr ivat e use 943.00
VAT = 17.5% x £ 943.00 £ 165.03
E7.7 Non-business use of services supplied to a business (deemed supply)
Wher e a per son car r ying on a business put s ser vices supplied to him t o any pr ivat e or non-business use, he is t r eat ed as having supplied t hose ser vices in t he cour se or f ur t her ance of t he business. The value of t he supply is t hat par t of t he
value of t he supply of t he ser vices t o him as r easonably r epr esent s t he cost t o SI 1993/ 1507 him of pr oviding t he ser vices. Wher e t he ser vices ar e put t o a pr ivat e or non- business use on mor e t han one occasion, t he t ot al VAT liabilit y under t hese pr ovisions cannot exceed t he input t ax claimed when t he ser vices wer e obt ained.
This r ule does not apply t o ser vices gener at ed int er nally, e.g. a solicit or s pr act ice under t aking conveyancing f or an employee f r ee of char ge. Ther e ar e no input t ax deduct ions, t her ef or e t he deemed supply r ules ar e not in point .
E7.8 Motor fuel provided for private use (deemed supply)
I f a business buys pet rol or diesel and allows pr ivat e use of it by an employee or t he owner of t he business, t he par t ner or sole t r ader , t hen ef f ect ively t he s.56
business has t hr ee choices as t o what it will do f r om a VAT point of view. The f irst choice is t hat it could claim all input tax incur r ed on all f uel pur chased and s.57 t hen, using t he scale charges set by Cust oms, calculate t he appr opr iat e out put t ax. The f uel scale r at es ar e dependent on engine size and whet her t he f uel is pet r ol or diesel. The scale r at es ar e VAT inclusive so you mult iply t hem by 7 over 47 t o f ind t he out put t ax due.
The second choice is t o claim absolutely no input tax on all f uel purchased. As Not ice 748 t her e ar e no input t ax issues t her e is no need f or any out put t ax calculat ions. ESC 3.1
Deemed Supplies 475
The f inal choice is f or a business t o keep very detailed mileage records so t hat t hey can pr ove t hat t he f uel t hat t hey have bought is only used f or business pur poses and ef f ect ively t he business t her ef or e does not pay anyt hing t owar ds t he cost of f uel used f or pr ivat e pur poses. I n such a case input t ax can be r ecover ed and t her e is no out put t ax char ge.
Example 1
J onas Limit ed pur chases pet r ol in t he quart er ended 30 Sept ember f or £ 302.50. The pet r ol was f or J onas’s car in which he t r avels 1,000 business miles and 1,000 pr ivat e miles.
The appr opr iat e quar t er ly f uel scale char ge is, say, £ 500.
What is t he net VAT payable or (r ecover able) f or t he business f or t his quar t er if it wishes t o r ecover t he input t ax on t he f uel?
E7.9 Goods held on deregistration (deemed supply)
When a business der egist er s f or VAT t his will mean t hat t he asset s cont ained in Sch 4 t he business, when event ually sold, will not have VAT char ged on t heir sale. I n Par a 8
t his sit uat ion we have a special r ule which says t hat when a business der egist er s f or VAT t her e is a deemed supply at t he dat e of der egist r at ion on all t he asset s t hat wer e held on t he dat e t he business der egist er ed. The out put t ax is char ged on r eplacement cost of t he asset s. Replacement cost is t he cost of an asset in Sch 6 exactly the same condition. This rule only applies t o asset s on which input t ax Par a 6 was claimed or iginally. For example if t her e is a car in t he business when it der egist er s, and t her e was no init ial input t ax r ecover y on t hat car , out put t ax is not char ged.
Ther e is also no charge if the output tax t hat is due comes t o £1,000 or less.
The following are excluded from the charge to VAT:
• Goods bought f r om unr egist er ed businesses. • Mot or car s (except qualif ying car s on which input t ax has been claimed). • Goods bought under t he pr ovisions of one of t he second-hand schemes. • Goods used wholly f or business ent er t ainment . • Goods t hat have been dir ect ly at t r ibut ed t o an exempt business act ivit y (unless t he input t ax was r eclaimable t hr ough t he par t ial exempt ion r ules). • Goods not bought f or business pur poses. • Land or buildings which wer e pur chased under an exempt supply even t hough (i) t he opt ion t o t ax has been exer cised and subsequent ly st andar d- r at ed supplies have been made and/ or input t ax r ecover ed on t he r ef ur bishment of t he building; or (ii) without the option to tax they have ot her wise been used t o make st andar d-r at ed supplies (e.g. holiday accommodat ion).
476 Principles of Business Taxat ion ‘Finance Act 2006’
• Land or buildings which wer e pur chased under a supply on which VAT was r ecover ed (e.g. wher e a f ully t axable business buys a new commer cial pr oper t y) if at t he t ime of der egist r at ion t he sale would be exempt (because t he business has not opt ed t o t ax t he propert y which is t hen over t hr ee year s old). I n such cir cumst ances, VAT due on t he supply of t he pr oper t y would be nil and so not exceed t he £ 1,000 limit .
Wher e a business has st andar d-r at ed land or buildings on hand at t he t ime of der egist r at ion on which it claimed input t ax deduct ion, t he VAT Not ice pr oper t y is deemed t o be supplied on der egist r at ion. To avoid t he cash 700/ 11/ 02 f low problem t hat t his might creat e, t he business could def er t he Par a 6.2 cancellat ion of r egist r at ion unt il t he pr oper t y is sold so t hat it would t hen be r equir ed t o account f or out put t ax on t he act ual sale of t he pr oper t y. Cust oms ar e pr epar ed t o consider , if necessar y, def er r ing t he cancellat ion of r egist r at ion longer t han t he nor mal six mont hs, unt il af t er t he pr oper t y is sold.
E7.10 Construction services (self supply)
The self supply of const r uct ion ser vices r ule applies t o pr event exempt or par t ially exempt businesses f r om employing t heir own people t o car r y out SI const r uct ion ser vices r at her t han using a t hir d par t y contractor to carry out the 1989/ 472 const r uct ion ser vices f or t hem who, of cour se, will char ge t hem VAT, which t hey pr obably could not r ecover in f ull.
The self -supply r ule applies wher e t her e is a construction of a building or an extension to an existing building – t he ext ension increasing floor space by at least 10%.
The value of t he const r uct ion ser vices must be over £100,000 in a year f or t his self -supply r ule t o apply.
The self -supply r ule basically calculat es out put t ax on t he open mar ket value of t he const r uct ion ser vices and so t his out put t ax has t o be account ed f or by t he business on t he VAT Ret ur n.
By t he same t oken, t his out put t ax f or ms input t ax which t he business can r ecover in t he nor mal way so, if it uses t he building t o make t axable supplies in any way, t hen t hat pr opor t ion of input t ax can be r ecover ed.
I nput t ax act ually incur r ed on goods and ser vices f or such building wor ks ar e t r eat ed as r elat ing t o t he t axable self -supply and can be deduct ed in f ull (subj ect t o t he nor mal r ules).
Ther e ar e pr oposals in t he FA2006 t o r epeal t he pr ovisions r elat ing t o t he developer ’s self supply char ge in Schedule 10 when Schedule 10 is r ewr it t en – a pr ocess which is under way.
Deemed Supplies 477
E7.11 Motor cars (self supply)
The self -supply char ge on mot or car s applies wher e a car dealer pur chases a car f r om a manuf act ur er t o put int o st ock. Because t he car is par t of his st ock, he is allowed t o r ecover input t ax in f ull on t hat car (new and f or resale). Then the car dealer t akes t he car out of st ock f or pr ivat e use. Nor mally t he pur chase of SI 1992/ 3122 a car f or pr ivat e use is subj ect t o a blocking or der on t he input VAT which Art 5 basically means input VAT on a mot or car cannot be r ecover ed. The self supply legislat ion aims to stop a car dealer being able to get a car into private use and yet still recover input tax.
The self -supply char ge claws back t he VAT t hat was r ecover ed when t he mot or car was purchased as stock. I t is calculated on the cost of the car and not on t he selling pr ice of t he car . The t r ader will have t o account f or out put t ax on t he self supply. Ther e will be no r elat ed input t ax claim as t he car is not wholly f or a business pur pose – it is blocked under SI 1992/ 3122 Art 5.
VAT on the purchase of demonstrator cars provided by motor dealers and manuf act ur er s is excluded f r om t he blocking or der which gener ally pr event s VAT r ecover y on t he pur chase of mot or car s. I nst ead, VAT is due on t he pr ivat e use of such car s. Cer t ain businesses have sought t o minimise t he VAT due on pr ivat e usage by char ging employees a nominal sum f or t he use of t he car .
Following FA2004, f r om a dat e t o be announced, t he Commissioner s will be able to direct that VAT is to be account ed f or on t he open mar ket value of demonst r at or car s supplied t o employees. This measur e r equir es a der ogat ion f r om Eur opean Communit y legislat ion; such a der ogat ion has been applied f or .
Ther e ar e some ot her self -supply r ules in t he VAT legislat ion but t his chapt er has cover ed t he main ones t hat you are likely t o see in pr act ice.
Example 2
Dr aw a line bet ween t he supply and t he cor r ect t it le box.
Goods and ser vices Car s bought for Mot or f uel bought f or business business use and pur chased by use and supplied f r ee t r ansf er r ed t o business f or f or pr ivat e use pr ivat e use pr ivat e use
I n-house Goods held on const r uct ion der egist r at ion ser vices
DEEMED SUPPLY SELF-SUPPLY
478 Principles of Business Taxat ion ‘Finance Act 2006’
Answer 1
The business bear s t he cost of pr ivat e f uel and so the choice it has made is to r ecover input t ax in f ull but t hen t o char ge out put t ax using t he scale char ge. The business mileage act ually t r avelled by t he car is ir r elevant except t hat we need to know that it does actually do some private mileage. We take our scale charge of £ 500 which is VAT inclusive, mult iply it by 7 over 47 t o get our out put t ax. We t hen t ake t he cost of t he pet rol £ 302.50, which again is VAT inclusive, mult iply it by 7 over 47 t o get our input t ax and t his leaves us wit h net VAT payable of £ 29.42 by t he company.
The business bear s t he cost of pr ivat e f uel.
Out put t ax £ £ 500 x 7/ 47 74.47 I nput t ax £ 302.50 x 7/ 47 (45.05)
Net VAT payable 29.42
I n t his example J onas Limit ed should be advised t o claim no input t ax on f uel. I f t his wer e t he case, t he f uel scale charge need not be account ed f or and t he business would save £ 29.42 t his quar t er .
Deemed Supplies 479
Answer 2
Goods and ser vices Car s bought for Mot or f uel bought f or business business use and pur chased by use and supplied f r ee t r ansf er r ed t o business f or f or pr ivat e use pr ivat e use pr ivat e use
I n-house Goods held on const r uct ion der egist r at ion ser vices
DEEMED SUPPLY SELF-SUPPLY
480 Principles of Business Taxat ion ‘Finance Act 2006’
SUMMARY – DEEMED SUPPLIES AND SELF-SUPPLIES
This chapt er has looked at t wo t ypes of supply – deemed supplies and self supplies. The r ules t hat apply t o bot h of t hese supplies ar e ver y similar and t hey ar e mainly t o pr event a loss of VAT and a dist or t ion of compet it ion.
However , it is impor t ant t o cat egor ise t he supplies separ at ely because a self supply is wher e we char ge VAT on an it em t o our selves. Thus t her e is an out put t ax char ge and an equal and opposit e input t ax cr edit on a self supply. I nvariably f ull recovery of input t ax is not achieved and t he self supply achieves it s obj ect ive.
The t r eat ment of a deemed supply is an out put t ax char ge due t o t he f act t hat input t ax has alr eady been claimed. This will nor mally be in ef f ect wher e t he onwar d supply (if any) is not subj ect t o VAT.
On a gif t of goods input t ax is clawed back on t hose goods wher e t hey ar e gif t ed f or non business use. The way to do this is to make an output tax charge on the r eplacement cost of such goods.
Wher e a business asset is used pr ivat ely, and t he Lennar t z appr oach is adopt ed, t hen t her e is an out put t ax char ge in ever y VAT quar t er in which pr ivat e use t akes place. The out put t ax char ge r ef lect s t he cost of pr oviding t he asset f or pr ivat e use. I n t he absence of Lennar t z t he nor mal appor t ionment pr ovisions under s.24(5) will apply.
Tr ader s must account f or out put t ax on t he deemed supply of bought in ser vices wher e t hey ar e put t o a non business use.
Wher e a business pur chases f uel f or pr ivat e use by an employee or t he owner of a business t hen wher e input t ax is r ecover ed on t hat pur chase, out put t ax must be account ed f or using t he scale char ges set by Cust oms.
Any asset s held by a business when it de-r egist er s f or VAT must have out put t ax account ed f or based on t heir r eplacement cost . However , if t he out put t ax due comes t o £ 1,000 or less Cust oms waive t he r equir ement t o pay over t he out put t ax.
The self supply r ule applies wher e const r uct ion ser vices ar e pr ovided by an exempt or par t ially exempt business t o it self .
A self supply char ge occur s wher e mot or car s ar e t aken out of st ock f or use by an employee or owner of a business.
E8: VALUE OF THE SUPPLY
I n t his chapt er we shall look at how you value a supply. The chapt er will cover : - t he def init ion of considerat ion; - special r ules f or valuing supplies in cer t ain sit uat ions; - pr ompt payment discount ; - mixed and composit e supplies.
E8.1 Introduction
The gener al r ules f or det er mining t he value of a supply of goods or ser vices ar e t o be f ound in
• VATA 1994, s 19(2) wher e t he consider at ion f or t he supply is wholly in money; and • VATA 1994, s 19(3) wher e t he consider at ion is not wholly in money.
These gener al r ules ar e, however , subj ect t o any special valuat ion r ules made by VATA 1994 or under VATA 1994. These special r ules ar e consider ed in 8.4 below. S 19(1)
E8.2 Consideration wholly in money
The gr oss value of t he supply is t he value of t he consider at ion t hat is given f or it . Ther ef or e t he st ar t ing point f or VAT is what a t r ader r eceives f or a supply s.19 (2) r at her t han what t he t r ader act ually supplies.
Consider at ion = Price of t he it em + t he VAT
Ther ef or e t he nor mal calculat ion is t hat 40/47ths of t he consider at ion is the net price and 7/47ths is the VAT. Tr ade pr ices and cont r act s usually st at e t hat t he pr ice is VAT exclusive so t his would mean t hat t he pr ice being quot ed is t he value of t he supply and t hat VAT will be added on t op of t his pr ice at 17.5%. (Host git t Lt d v Megahar t Lt d) However , in pr act ice, t his pr ocedur e is act ually t he opposit e of t he VAT r ules because t he VAT r ules say t hat wher e a cont r act says not hing about VAT t hen t he st ar t ing point is t he consider at ion so, in ot her wor ds, if you ar e quot ed a cer t ain pr ice and VAT is not ment ioned, t hat pr ice is VAT inclusive and hence is t he consider at ion. This is what happens when people go shopping in super mar ket s and shops, t he pr ice t hey see, which never ment ions VAT, is t he pr ice including VAT.
482 Principles of Business Taxat ion ‘Finance Act 2006’
Example 1
Out lined below ar e t hr ee it ems or ser vices being sold; you have t o calculat e t he t ax t o t he near est penny. a) Mar ks & Spencer sell a ladies coat at £ 99.00 VAT due is £ b) A plumber char ges £ 250 plus VAT t o r epair a leaky t ap VAT due is £ c) A book cost s £ 12.00 in Wat er st one’s Book Shop VAT due is £ However , r at her unusually, wit h ef f ect f rom 17 March 2005, t he considerat ion payable t o an over seas supplier of nat ur al gas and elect r icit y is t he value on which VAT is t o be account ed f or. This f ollows t he changes in t he place of supply r ules r elat ing t o t hese ser vices which wer e int r oduced f r om 1 J anuar y 2005.
E8.3 Consideration not wholly in money
I f a supply is f or a consider at ion not consist ing, or not wholly consist ing, of money, subj ect t o t he special valuat ion r ules in 8.4 below, it s value is t o be t aken VATA 1994 to be such amount in money as, with addit ion of t he VAT char geable, is S 19(3) equivalent t o t he consider at ion. I n ot her wor ds, it is necessar y t o
• det er mine t he amount t hat would have been given in money f or t he supply if goods or ser vices had not inst ead been used f or all or par t of t he payment ; and t hen • mult iply t hat amount by t he VAT f r act ion t o est ablish how much VAT is due. It is important to distinguish between non-monetary consideration and no consideration. Non-monet ar y consider at ion exists when a supply is made in r et ur n f or payment in t he f or m of goods or ser vices. Wher e t her e is only non- monet ar y consider at ion, a bar t er t r ansact ion t akes place. I n some cases t her e may be bot h a monet ar y consider at ion and a non-monet ar y consider at ion. When goods or ser vices ar e pr ovided f or no payment in any f or m (monet ar y or non-monet ar y), t her e has been no consider ation. It is then only necessary to value such a pr ovision of goods or ser vices wher e VATA 1994 deems a t axable supply t o have t aken place. The commonest cases ar e • pr ivat e or non-business use of business asset s f or no consider at ion; • pr ivat e or non-business use of ser vices supplied t o t he business; • supplies of business goods/ asset s f or no consider at ion; and • deemed supplies of business goods/assets on hand at the time of der egist r at ion.
These wer e cover ed in det ail in Chapt er 7.
Value of t he Supply 483
E8.4 Special Rules
Schedule 6 of VATA 1994 cont ains special r ules f or valuing supplies in cer t ain sit uat ions. Cust oms can dir ect t hat an open mar ket value is used f or supplies bet ween cer t ain connect ed per sons. This will nor mally apply wher e t he pur chaser cannot r ecover all of t he input t ax being char ged (f or example, an Sch 6 exempt or a par t ially exempt t r ader ). For t he r ule t o apply t he consider at ion Par a 1 must be wholly in money f or less t han open mar ket value. Ther e must t her ef or e be some consider at ion f or t he open mar ket value t o be applied bet ween connect ed per sons. I f t her e is no consider at ion, f or example, it is some sor t of bar t er t r ansact ion, t his r ule cannot be applied.
I f a mail or der company sells goods using unr egist er ed agent s, t hen t hat mail or der company can be f or ced by Cust oms t o account f or VAT on t he f ull r et ail Sch 6 pr ice of t hose goods. I f t his was not t he case, t hen t he mar gin of pr of it given Par a 2 t o t he agent would escape a char ge of VAT and, t he VAT being paid would not be 7/ 47t hs of t he act ual amount paid by t he cust omer . Wher e t her e is a supply of goods by vir t ue of • a Tr easur y or der under VATA 1994, s 5(5) (self -supply of goods,), • VATA 1994, Sch 4 para 5(1) (gif t s of business asset s), • VATA 1994, Sch 4 para 6 (r emoval of business asset s f r om one EC count r y t o anot her ), or • VATA 1994, Sch 4 para 8 (deemed supply on der egist r at ion and t er minat ion of business), t hen, (subj ect t o except ion in Sch 6 par a 10) t he value of t he supply is (a) such consider at ion in money (excluding any VAT) as would be payable by t he per son making t he supply if he wer e, at t he t ime of t he supply, t o pur chase goods ident ical in ever y r espect (including age and condit ion) t o t he goods concer ned; (b) wher e t he value cannot be det er mined as under (a) above, such consider at ion in money (excluding any VAT) as would be payable by t hat per son if he wer e, at t hat t ime, t o pur chase goods similar t o, and of t he same age and condit ion as, t he goods concer ned; and
(c) Wher e t he value cannot be det er mined as under (a) or (b) above, t he VATA 1994 cost of pr oducing t he goods concer ned if t hey wer e pr oduced at t hat t ime. Sch 6, par a 6 Wher e an employer makes a supply of goods or ser vices t o his employees consist ing of
• f ood or bever ages supplied in t he cour se of cat er ing, or • accommodat ion in a hot el, inn, boarding house or similar est ablishment ,
t he value of t hat supply is t o be t aken t o be t he monet ar y consider at ion, if any, VATA 1994 paid by t he employee (i.e. t he consider at ion is nil wher e t her e is no consider at ion Sch 6 or any consider at ion ot her t han money). Par a 10
484 Principles of Business Taxat ion ‘Finance Act 2006’
Wher e accommodat ion in a hot el, inn, boar ding house or similar est ablishment is
• pr ovided t o an individual f or a per iod exceeding f our weeks, and • t hr oughout t hat per iod t he accommodat ion is pr ovided f or t he use of t he individual eit her alone or t oget her wit h one or mor e per sons who occupy t he accommodat ion wit h him ot her wise t han at t heir own expense,
af t er t he init ial f our weeks t he value of t he supply is r educed t o t hat par t VATA 1994 attribut able to f acilities other than t he r ight t o occupy t he accommodat ion Sch 6 (subj ect t o a minimum of 20%). Par a 9
I f a supply is invoiced in a f or eign cur r ency, then that supply is valued at the Sch 6 appr opr iat e exchange r at e in f or ce on t he day t he supply is made. Par a 11
E8.5 Prompt Payment Discount
Some t r ader s of f er a pr ompt payment discount t o encour age cust omer s t o pay on a t imely basis. When valuing goods f or VAT always assume t hat if a pr ompt Sch 6 payment discount is of f er ed, t he discount will be taken up by the customer. Par a 4 Thus t he VAT is always char ged on t he discount ed pr ice whet her or not t he discount was act ually t aken.
Illustration 1
Let us say t hat a t r ader sells goods f or £ 500 exclusive of VAT. This t rader of f er s a 10% discount if payment is made wit hin 7 days. The goods are £ 500 if you pay lat e, or £ 500 less a 10% discount , so £ 450, if you pay ear ly.
Because a pr ompt payment discount is of f er ed, whet her it is t aken or not , VAT is calculat ed on t he discount ed amount. Thus the VAT is calculated on the £ 450 value of goods, which at 17.5% gives £ 78.75 of VAT. This is added on t o £ 500 wor t h of goods if t he goods ar e paid f or af t er 7 days, (£ 578.75) or it is added on t o t he £ 450 wort h of goods if t he goods ar e paid f or wit hin 7 days (£ 528.75).
Example 2
J oe sells goods f or £ 1,000 exclusive of VAT t o ABC Limit ed. J oe of f er s a 2% discount f or payment wit hin 10 days. Calculat e t he VAT due if ABC Limit ed pays 30 days lat er.
E8.6 Further points
The next it em t o consider is a gif t . A gif t is wher e goods ar e given over t o one per son but no consider at ion is given back f or t he goods. For VAT you must value Sch 6 t he goods and you value t hem at t heir r eplacement cost . VAT is t hen char ged on Par a 6(1) a consider at ion which equals t he r eplacement cost of t hose goods.
Value of t he Supply 485
For a bar t er t r ansact ion, (i.e. I give you goods and in r et ur n you give me somet hing back, but not money), we ar e ef f ect ively looking at non-monet ar y s.19(3) consider at ion. The legislat ion st at es t hat t his non-monet ar y consider at ion must be valued and t his value is what t he out put t ax is calculat ed in r espect of .
E8.7 Mixed and Composite Supplies
Ther e ar e t wo dif f er ent t ypes of supply. The mixed (or mult iple) supply and t he composite (or compound) supply.
A mixed supply is wher e t her e ar e individual elements wit hin t he supply t hat ar e treated separately for VAT. An example of t his would be wher e a st udent goes on a cour se and has t o pur chase some books as par t of t he cour se. A cour se is st andar d r at ed and books ar e zer o-r at ed. They ar e ef f ect ively t r eat ed as separ at e supplies, even t hough t he st udent might pur chase t hem t oget her . The individual element s ar e being t reat ed separ at ely f or VAT.
This is cont r ast ed t o t he composite supply wher e t her e is j ust a single supply alt hough it might be made up of lot s of dif f er ent t hings. A compound supply is a single supply wit h a single VAT liability. An example of t his is a plane t icket t o f ly t o New Yor k. The t r aveller will also pr obably be pr ovided wit h a meal on t he f light . Air t r anspor t is zer o-r at ed and cat er ing is st andar d r at ed. However t he t r aveller is buying a complet e package and it is dif f icult t o separ at e t he t wo element s plus, of cour se, t he meal is j ust a small insignif icant piece of t he over all f light t o New York. I n such a case, t his composit e supply would j ust be t reated as a single zer o-r at ed supply of a plane t icket t o New Yor k.
Wit h a mixed supply, t her e is t he need t o per f or m an appor t ionment calculat ion s.19(4) t o split t he individual element s of t he supply in or der t o calculat e t he VAT due.
Wit h a compound supply only a single r at e of VAT applies t o t he whole supply.
The case of Car d Prot ect ion Plan conf ir med t hat t he pur chaser ’s per cept ion of what t hey ar e buying is t he key f act or in det er mining whet her a supply is a mixed or composit e supply. When you buy a plane t icket , t he in f light meal is ancillary t o t he plane t icket and t her ef or e t he supply is a composit e supply of air t r avel. I f t he pur chaser believes t he t wo element s of a supply ar e of equal impor t ance t he supply will gener ally be mixed and subject t o an appor t ionment calculat ion.
Illustration 3
A t r aining company of f er s a lect ur e course and st udy mat er ials f or £ 2,000 plus VAT. The cost t o t he t r aining company f or t he manuals is £ 100 and t he cost of t he cour se is £ 500.
The manuals ar e a zer o-r at ed supply of pr int ed mat t er and t he cour se a st andar d –rat ed supply. This is a mixed supply.
486 Principles of Business Taxat ion ‘Finance Act 2006’
Not ice 700 published by HMRC suggest s using eit her t he cost of each element or t he selling pr ice of each element t o appor t ion t ot al consideration. In our Not ice 700 illust r at ion we shall use cost t o appor t ion t his mixed supply. The t ot al cost of £ 500 and £ 100 is £ 600.
100 X £2,000 = zero rated output = £333 600
500 X £ 2,000 = st andar d r at ed out put = £ 1,667 600
£ 2,000
VAT due:
£ 333 @ 0% £ nil
£ 1,667 @ 17.5% 291.73
Tot al VAT Due: £ 291.73
Example 3
For each of t hese supplies decide whet her t her e is a mixed / mult iple supply or a compound / composit e supply. Mixed/ Compound/ Mult iple Composit e Supply Supply
a) A box of Ear l Grey Tea comes wit h a china t eapot as a special Chr ist mas pr omot ion
b) A language school sells cour ses and books f or a total f ee of £ 500.
c) Ticket to f ly to Rome includes a st andar d lunch
Value of t he Supply 487
Answer 1
a) £ 14.74 The f irst it em is f or sale in Marks & Spencer and t he pr ice shown will be t he consider at ion, i.e. t he VAT inclusive price. Thus 7/ 47 of £ 99 gives us £ 14.74.
b) £ 43.75 The second it em is a plumber char ging £ 250 plus VAT f or ser vices, so t he pr ice being shown is not t he consider at ion because t he VAT is not included and has t o be added on t op t o get t o consider at ion. To wor k out t he VAT we char ge 17.5% of £ 250 and get £ 43.75.
c) Nil The third item is a book being sold for £12. I t is a shop, just like t he Mar ks & Spencer example, so t he pr ice being shown is t he consider at ion. Nor mally we would t ake 7/ 47 f or t he VAT except books ar e zer o-r at ed supplies so it is act ually 0% VAT added on t o t his pr ice paid t o give us bot h a pr ice paid and a consider at ion of £ 12 and zer o VAT.
Answer 2
The cor r ect answer calculat es VAT on t he discount ed amount even t hough t he discount was not t aken because t he company paid lat e. £ 1,000 less 2% discount is £ 980, which at 17.5%, gives us £ 171.50 of VAT. The company will pay £ 1,000 plus £ 171.50 of VAT (i.e. £ 1,171.50).
Answer 3
A box of Ear l Grey t ea is t he main supply her e. The china t eapot , which pr obably cost s a lot mor e t han t he t ea, is j ust a promot ional incident al supply. This is ver y similar t o t he case wit h t he biscuit t in in United Biscuits Limited. This is a single supply, a compound / composit e supply, of Earl Grey t ea which will be zero- r at ed.
A language school selling a cour se and books will pr obably be making a mixed / mult iple supply because you will be able t o appor t ion VAT bet ween t he t wo element s pr ovided, i.e. t he cour se and t he books.
I f you buy a t icket t o f ly somewher e and t hey pr ovide a meal, t he meal is generally just an incidental part of the main supply. So this would be a zero- r at ed single compound supply of air t r anspor t ser vices, wit h t he st andar d r at ed cat er ing meal being incident al t he main supply, and hence ignor ed.
488 Principles of Business Taxat ion ‘Finance Act 2006’
SUMMARY – VALUE OF THE SUPPLY
VAT is 7/ 47t hs of t he considerat ion.
Consider at ion not wholly in money is valued f r om t he point of view of t he per son r eceiving t he consider at ion wher e t hey ar e awar e of t he r et ail pr ice of t he goods or ser vices r eceived (Nat ur ally Your s). Where t hey ar e unawar e of t he r et ail value, consider at ion is valued at cost t o t he supplier of t he goods (Empir e St or es).
I f t her e was a pr ompt payment discount of f er ed always deduct it when calculat ing VAT even if t he discount is not act ually t aken up by t he cust omer .
A gif t needs t o have a value f or consider at ion in or der t o wor k out VAT and we would use r eplacement value in such a case.
I f we ar e looking at a bar t er t r ansact ion t hen t he value of consider at ion is t he value of t he non-monet ar y consider at ion we ar e r eceiving.
A mixed/ mult iple supply is a supply t hat you can appor t ion int o it s individual element s and t hen char ge VAT upon each element accor dingly.
A composit e/ compound supply is r eally j ust a single supply wit h a single VAT liabilit y. I f t her e ar e separ at e element s t hen t her e must be a main supply wit h t he ot her element or element s j ust being incident al t o t hat main supply.
E9: TIME OF SUPPLY
I n t his chapt er we will have a look at t he f ollowing: - how t he t ime of a supply is calculat ed; - t he sit uat ions when a basic t ime of supply (t ax point ) can be over r idden and changed t o a dif f er ent dat e; - t he t ime of supply wher e deposit s ar e paid f or a supply; - special r ules which f ix t ax point s f or unusual sit uat ions t hat t he t r ader may incur .
E9.1 Introduction
The t ime of supply is a ver y impor t ant piece of t he VAT legislat ion because t he t ime of supply basically gives you a dat e on which an it em is purchased or an it em is sold. That dat e is cr ucial because it will det er mine which VAT Ret ur n you s.1(2) account f or t he out put t ax on a sale or you r ecover t he input t ax on a pur chase.
The dat e is also cr ucial in case t her e was a change in t he r at e of VAT because t he dat e will det er mine which r at e of VAT t o char ge – t he old or t he new r at e. I t is also cr ucial if t her e was a change in t he law because t he dat e will f ix when t he supply occur s and whet her it happens under t he old law or t he new law. The t ime of supply is ver y impor t ant especially when pr epar ing your VAT Ret ur n since it det er mines which it ems t o put on a par t icular VAT Ret ur n. I f a business put s a t r ansact ion in t he wr ong VAT Ret ur n t he business opens it self up t o penalt ies.
The main r ule is t hat t her e is a basic tax point f or all goods and all ser vices supplied.
E9.2 Basic tax point
For goods t he basic t ax point is t he dat e t he goods are removed f rom the s.6(2) supplier t o t he pur chaser so, f or example, if a cust omer goes int o a shop and
pur chases a sandwich, he is r emoving t he sandwich f r om t he supplier on t he dat e t hat he buys t hat sandwich. I f , as anot her example, he orders some widget s – it is t he dat e t hose widget s leave t he f act or y wher e t hey ar e being manuf act ur ed in or der t o come t o t he cust omer t hat det er mines t he basic t ax point – t he dat e of supply.
For ser vices, t he dat e of supply is when the services are performed. For s.6(3) ‘per f or med’ t hink of ‘complet ed’. I f a plumber comes t o your house t o inst all cent r al heat ing, t hen it is t he dat e he f inishes t he inst allat ion – t he dat e t he ser vices ar e r eally per f or med and f inished – t hat is t he basic t ax point .
490 Principles of Business Taxat ion ‘Finance Act 2006’
E9.3 Basic tax point overridden
The basic t ax point can act ually be over r idden by a dif f er ent dat e in t wo sit uat ions. One sit uat ion act ually makes t he act ual t ax point we use ear lier t han t he basic t ax point dat e. This will occur wher e t her e is a receipt of a payment s.6(4) on a dat e bef or e t he basic t ax point dat e or when t he tax invoice is issued on a dat e bef or e t he basic t ax point dat e. I n t hese cases, t he earlier date becomes the actual tax point date t hat we will use.
The second scenar io gives us a lat er t ax point dat e t han our basic t ax point . The lat er t ax point will only apply if we have not had an ear lier t ax point imposed on us. So our starting point is our basic t ax point dat e. I f a tax invoice is issued in the 14 day period after the basic tax point date t he t ax invoice issue dat e, i.e. t he lat er dat e, becomes t he act ual t ax point t hat we will use. The trader can waive this 14 day rule if he does not want t o have t his lat er dat e as s.6(5) his tax point. He can chose to stick wit h t he basic t ax point dat e. Cust oms have t he power t o ext end t he 14 day per iod and, in many cases, t hey will ext end it up to 30 days. A 30 day extension would help businesses that only have one invoice r un – usually at t he end of ever y month. This allows those businesses to use t he invoice dat e as t heir act ual t ax point f or all supplies made in t hat mont h.
Illustration 1
Anne or der s a wedding dr ess f r om Dr esses Limit ed on 1 November 2006. The company makes t he dr ess in November and Anne collect s t he dr ess on 1 December 2006. The company issues an invoice on 9 December 2006, which Anne pays on 20 December 2006.
Basic t ax point - 1.12.2006
Ear lier t ax point - Not applicable
Lat er t ax point - 9.12.2006
Act ual t ax point used = 9.12.2006
The basic t ax point is t he dat e t hat t he goods, t he wedding dr ess, is r emoved f r om t he supplier t o t he pur chaser – so t his will be t he dat e t hat Ann collect s t he dr ess and hence will be 1 December 2006. I f t her e was a payment made bef or e t his dat e or t he t ax invoice was issued bef or e t his dat e t hen an ear lier t ax point would apply. That is not what happens in t his example.
I f t he t ax invoice is issued wit hin 14 days of t he basic t ax point , t hen t he lat er dat e becomes t he act ual t ax point we use. The invoice was issued on 9 December 2006 – t his is wit hin 14 days of our basic t ax point on 1 December 2006 hence t he lat er t ax point is t he act ual t ax point t hat we will use f or t his supply, unless t he company waives t he r ight t o use t he lat er dat e which is not ver y of t en t he case in pr act ice.
Time of Supply 491
Example 1
Same as I llust r at ion 1 except Anne order s t he dr ess on 1.11.2006, pays f or t he dr ess on 1.12.2006, collect s t he dr ess 5.12.2006 and t he invoice is issued on 9.12.2006.
Which of t he f ollowing is t he t ax point f or t he supply?
a) 1.11.2006
b) 1.12.2006
c) 5.12.2006
d) 9.12.2006
E9.4 Deposits
I t is possible to have more than one tax point f or t he same supply – an example of t his would be wher e a deposit is paid upf r ont and t hen, when t he goods ar e deliver ed at a lat er dat e, t he balance is paid.
Illustration 2
Let us have a look at how a deposit would af f ect t he example wit h Anne. Anne or der s a dr ess on 1 November and pays her £ 500 deposit when she or der s t he dr ess on 1 November . She t hen collect s t he dr ess on 1 December . The company t hen invoices Anne f or t he balance due on 9 December and Anne pays t he balance on 20 December .
St ar t ing wit h t he deposit . The basic t ax point f or t his supply is t he dat e t hat t he dr ess is collect ed on 1 December 2006. The deposit was paid ear lier t han t he basic t ax point – it was paid on 1 November and t he nor mal t ax point r ules would say t hat t he ear lier dat e is t he dat e used as t he t ax point .
Thus 1 November becomes t he act ual t ax point f or t he deposit because it was ear lier t han t he basic t ax point f or t he supply.
When consider ing t he balance of t he payment , once again t he basic t ax point is t he dat e t he dr ess is collect ed on 1 December . The company t hen issue an invoice f or t he balance t hat is due on 9 December. This is wit hin 14 days of t he basic t ax point f or t hat balance and hence t he lat er dat e is t he t ax point f or t he balance. So 9 December is t he t ax point f or t he balance.
Ther e ar e t wo t ax point s f or t his supply – 1 November is t he t ax point f or t he deposit , 9 December is t he t ax point f or t he balance.
492 Principles of Business Taxat ion ‘Finance Act 2006’
Anne:
Or der s dr ess 1.11.2006
Pays £ 500 deposit 1.11.2006 Tax point f or deposit
Collect s dr ess 1.12.2006 Basic t ax point
I nvoice f or balance 9.12.2006 Tax point f or balance
Pays balance 20.12.2006
E9.5 Special rules
I t is only possible t o issue a t ax invoice showing VAT payable f or a st andar d r at ed t axable supply by a r egist er ed per son. When you ar e looking at t he tax point of an exempt supply or a zero-rated supply, or a supply by an unregistered person (which could be impor t ant f or r egist r at ion liability calculat ions), t hen one does not consider the issue of a tax invoice. Thus when looking at t he t ax point r ules, one only looks at payment or basic t ax point s f or supplies t hat ar e not st andar d r at ed supplies.
Somet imes wit h ser vices t he ser vice can be supplied cont inuously and never
act ually f inish or , as t he legislat ion put s it ‘per f or med’. An example of t his would be r ent – a business is const ant ly being provided wit h t he propert y f or which it SI 1995/ pays r ent . Anot her example is consult ancy wor k, which can const ant ly be on going 2518 reg 90 but never r eally complet ed. For a continuous supply of services one does not
consider basic t ax point because t here is not one - t he ser vice is never
perf ormed so it is never completed. With a continuous supply of services there
is only payment and invoice – so t he earlier of t he t wo will det ermine t he t ax point .
Thus supplies which ar e subj ect t o t he cont inuous supply r ule gener at e a t ax SI 1997/ point only by t he issue of a t ax invoice, or payment passing. When t hese supplies 2887 r eg 2 ar e bet ween connect ed par t ies, f or example gr oup companies, t he char ges ar e
f r equent ly passed bet ween companies f or account ing pur poses, but no invoices
ar e issued. I n such a case, out put t ax is not declar ed nor is input t ax
r ecover able.
However , wher e t he input t ax would not be r ecover able, f or example because t he r ecipient is wholly or par t ially exempt , t his causes a loss of r evenue t o Cust oms. A r ule int r oduced by FA2003 imposes a per iodic t ax point on cont inuous supplies bet ween connect ed par t ies, gener ally leading t o an annual VAT out put t ax char ge. The t ype of supplies af f ected by t his new r ule ar e t hose f or management char ges, t elephone, elect r icit y, piped gas and wat er and leasing of pr oper t y and equipment .
Time of Supply 493
The t ax point f or supplies in t he construction industry depend upon t he t er ms of payment under t he cont r act f or t he supply.
(a) Wher e t he cont r act pr ovides f or per iodic payment s t o t he supplier (of t en r ef er r ed t o as st age payment s or int er im payment s) a t ax point ar ises at t he ear liest of t he f ollowing dat es.
(i) The dat e a payment is r eceived f r om t he supplier . (ii) The dat e t he supplier issues a VAT invoice. (iii) For const r uct ion ser vices wher e, br oadly, t he building in quest ion is occupied by a per son who cannot r ecover VAT and the const r uct ion cont r act or is connect ed wit h t he occupier or has been f inanced by t he occupier t o car r y out t he const r uct ion wor k.
• if t he ser vices wer e per f ormed af t er 8 December 1997 and SI bef or e 9 J une 1999, 18 mont hs af t er t he dat e on which t he 1995/ 2518 ser vices wer e per f or med; and Reg 93; SI 1997/ 2887, • if t he ser vices ar e per f or med af t er 8 J une 1999 t he dat e on Reg. 5; SI which t he ser vices ar e per f or med. 1999/ 1374
(b) Single payment cont r act s (even if payment of par t of t he pr ice is t o be SI 1995/ 2518 delayed under a r et ent ion clause) ar e subj ect t o t he nor mal t ax point Reg 89 r ules.
Wher e a cont r act wit hin (b) above includes a r et ent ion clause, t he t ax point of t he r et ained element is t he ear liest of t he t ime when a payment is r eceived in r espect of t he r et ent ion and t he dat e t he supplier issues an invoice r elat ing t o it.
When supplies ar e deemed t o be made under t he r ever se char ge r ules, t hen t he t ax point is only det er mined by payment . I n ot her wor ds, it is only det er mined by SI 1995/ 2518 t he dat e t he ser vices ar e paid f or . When t he ser vices ar e act ually per f or med, or r eg 82 when an invoice is issued is ir r elevant under t he reverse charge r ules.
Example 2
Kar en or der s a t oy over t he t elephone f r om a mail or der supplier quot ing her debit car d number on 12 November 2006. On 14 November 2006 t he supplier sends t he t oy t o Kar en. On 16 November 2006 an invoice is issued showing f ull payment has been made. Which of t he f ollowing is t he t ax point f or t he supply? a) 12.11.2006 b) 14.11.2006 c) 16.11.2006 d) 1.12.2006
494 Principles of Business Taxat ion ‘Finance Act 2006’
Answer 1
The cor r ect answer is B
The basic t ax point is t he dat e t he dr ess was collect ed which is 5 December .
However if a payment was made bef or e t his basic t ax point or if an invoice was issued bef or e t his t ax point , t hen we use t he ear lier dat e.
I n t his example a payment was made on 1 December and so t hat dat e becomes t he act ual t ax point t hat we would use f or t his supply.
Answer 2
The cor r ect answer is A
The basic t ax point is t he dat e t he goods wer e supplied or lef t t he pr emises of t he supplier ; so t hat would be 14 November .
Because a payment was made ear lier t han t his basic t ax point dat e, on 12 November 2006, we use t he ear lier dat e as t he t ax point dat e f or t hese supplies. The act ual t ax point used is t her ef or e 12 November 2006.
Time of Supply 495
SUMMARY – TIME OF SUPPLY
The basic t ax point f or goods is t he dat e t he goods ar e r emoved f r om t he supplier . The basic t ax point f or ser vices is t he dat e t he ser vice is per f or med.
The basic t ax point is over r idden in t wo sit uations. I f t her e is r eceipt of a payment or a t ax invoice is issued on a dat e bef or e t he basic t ax point dat e t hen t he ear lier dat e becomes t he act ual t ax point dat e used.
I f an ear lier t ax point does not apply and an invoice is issued wit hin 14 days af t er t he basic t ax point t hen t he invoice issue dat e becomes t he t ax point dat e used ,i.e. t he lat er dat e is t he t ax point used by t he business.
When consider ing deposit s, t he deposit and t he balance paid ar e consider ed separ at ely; each will have t heir own t ax point s calculat ed in t he nor mal way which mor e of t en or not ar e complet ely dif f er ent dat es f r om each ot her .
I f ser vices ar e supplied cont inuously, t hen t he t ax point becomes t he dat e money is paid or an invoice is issued. A special r ule exist s f or cont inuous supplies bet ween connect ed par t ies.
Supplies deemed t o be made under t he r ever se char ge r ules have a t ax point det er mined by t he dat e of payment .
E10a: INPUT TAX: WHEN TO RECOVER
I n t his chapt er we will look at when t o r ecover input t ax including: t he numer ous condit ions which must be sat isf ied bef or e input t ax can be r eclaimed by a business; - t he def init ion of a supply of goods or ser vices; - t he def init ion of t axable per sons; - t he def init ion of business pur poses; t he r equir ed evidence t o show t hat input t ax was cor r ect ly char ged; how we det er mine a dir ect and immediat e link wit h a t axable t r ansact ion; t he sit uat ions when input t ax r ecover y is not available.
E10a.1 Introduction
As a gener al r ule, when input VAT is incur r ed by a t axable per son it is available f or credit (which basically means it is included as input VAT on t he VAT Ret ur n) f or t he period in which it arises. I t is deduct ed f r om out put t ax and hence r ecover ed f r om Cust oms. I f t he input t ax on a VAT Ret ur n exceeds t he out put s.24 & s.26 SI 1995/ 2518 t ax, t hen Cust oms act ually make a r epayment of t he net amount . This chapt er is Reg 29 going t o look at t he conditions which have t o be met bef or e input t ax is available f or credit.
The condit ions ar e numer ous and can be summar ised as f ollows:
• A supply of goods or services is being made; • This supply must be made to the taxable person and t he t r ader is a t axable per son at t he t ime t he supply was made;
• The supply of goods or ser vices must have been made f or a business purpose; • The claimant must hold t he r equir ed evidence of t heir pur chase; • I nput t ax on t he supply must have been correctly charged; and • The goods or ser vices being supplied must have a direct and immediate link wit h a t axable t r ansact ion.
I n addit ion t o t hese condit ions t he input t ax must not be specif ically blocked f rom credit.
E10a.2 A supply of goods or services has been made
The f ir st condit ion is t hat a supply of goods or ser vices has been made. The supply must have act ually t aken place. I f a supply does not t ake place f or what ever r eason, t hen t he VAT element of anyt hing t hat has been paid is not r ecover able.
I nput Tax: When t o Recover 497
I f somet hing was paid, t hen it is f or t he cust omer t o go back t o t he seller and t r y t o get a r ef und. A r ef und cannot be obt ained f r om Cust oms because any payment made is not r egar ded as input t ax.
A classic example of t his is t he t r ansf er of a business as a going concer n (TOGC) because t his is not consider ed t o be a supply f or VAT. Hence, because no supply is being made, if any VAT has been char ged in r espect of such a t r ansact ion, it cannot be r ecover ed, f r om Cust oms.
E10a.3 Supply made to the taxable person
The second condit ion is t hat t he supply has been made t o t he t axable per son. I t is not accept able f or a supply t o be made t o somebody else but t he t axable s.24 person recovers t he input VAT on t hat supply. There is a case t hat looks at t his condit ion which is CCE v Redr ow Group Plc (1999).
Redr ow designed and oper at ed a sales incent ive scheme wher eby it would pay t he Est at e Agency f ees incur r ed by per sons selling t heir homes and pur chasing new Redr ow homes. The sum concer ned was paid on t he complet ion of t he pur chase. Redr ow submit t ed a claim t o r ecover t he input t ax on t he Est at e Agent s’ f ees. Cust oms ar gued t hat t he Est at e Agent ’s ser vices wer e not supplied t o Redr ow but r at her wer e supplied t o t he pur chaser s of t he new house. The case went f r om Tr ibunal t o High Cour t t o Cour t of Appeal and f inally, t o t he House of Lor ds.
The House of Lor ds f elt t hat t he quest ion in t his case was whet her t her e was input t ax in Redr ow’s hands which, in t ur n, depended on whet her Redr ow had r eceived t axable supplies f or t he pur pose of it s business. The House of Lor ds st at ed t hat Redr ow did not mer ely der ive a benef it f r om t he ser vices r ender ed t o t he pur chaser s of t he houses, but t hey had act ually select ed and inst r uct ed t he Agent s.
The Cour t t her ef or e concluded t hat Redr ow r eceived supplies of ser vices f r om t he Agent in r et ur n f or t he consider at ion paid. Consequent ly, t he t ax paid was input t ax in t he hands of Redr ow.
I n t he case of Mono Global Lt d t wo shar eholder s acquir ed a company wit h t he int ent ion of using it t o make supplies in t he t elecommunicat ions sect or . They sought out side invest or s, and t he company paid f or r epor t s on it s likely pr of it abilit y by t wo f ir ms of account ant s and t wo f ir ms of consult ant s. The company r eclaimed t he input t ax on t hese r epor t s, and Cust oms r ef used it , ar guing t hat t he supplies of t he r epor t s had r eally been made t o t he out side invest or s.
The Tr ibunal allowed t he company’s appeal in line wit h t he decision of t he House of Lor ds in Redr ow Group plc. Ther e was some benef it t o t he out side invest or s, but t he company was undoubt edly t he main r ecipient of t he supplies.
498 Principles of Business Taxat ion ‘Finance Act 2006’
The Tribunal held t hat “t he exact contr act ual r elat ionship concluded by t he pr of essional adviser s does not necessar ily det ermine t he ident it y of t he part y t o whom t he supply is made”. This indicat es t hat t he out side shar eholder – 3i – was ent er ed on t he let t er s of engagement along wit h t he “shell” company t hat became liable t o pay t he f ees at a lat er dat e. Cust oms t hought t hat t his was enough t o dist inguish t his case f r om Redr ow, but t he Tr ibunal disagr eed. The main benef it was always going t o be t o t he shell company, even if it did not have a name when t he cont r act s wer e ent er ed int o, and t he benef it s t o 3i wer e always incident al.
Employee expenses
St r ict ly, t he condit ion t hat t he supply must have been made t o t he t axable per son, means t hat if any input t ax is incur r ed on employee’s expenses which ar e t hen r eimbur sed by t he employer , t his input t ax is ir r ecover able.
Thus if an employee is sent away t o work and has t o st ay in a hot el over night , and t he company r eimbur ses his hot el bill, in t he st r ict r eading of t he law, input t ax on t hat hot el bill cannot be r ecover ed because t he bill is made out t o t he employee; t he employee was pr ovided wit h t he ser vice not t he employer . The case
of Co-oper at ive I nsur ance Societ y Lt d had t he input t ax being disallowed on
hot el accommodat ion r eser ved by employees and only deduct ible if reserved by t he company.
However , in pr act ice, Cust oms give cr edit in r espect of expenses t hat ar e Not ice 700 specif ically r eimbur sed. Par a 12.1
Cust oms do not allow r elief f or r ound sum expense allowances, even if t he employee account s f or expenditur e act ually incur r ed.
Similar pr ovisions apply t o employee mileage claims. Employees ar e nor mally r eimbur sed at 40p per mile f or each business mile t hey t ravel in t heir own car.
The employer can r ecover 7/ 47 of t he petrol element of such claims.
The aut hor it ies have published an appr oved list of r at es f or such claims. Fr om 1 July 2006 t hey are:
Engine size Rat e (f uel only/ f uel element ) Pet r ol: up t o 1400cc 11p per mile Petrol: 1401cc – 2000cc 13p per mile Pet r ol: over 2000cc 18p per mile Diesel: up t o 2000cc 10p per mile Diesel: over 2000cc 14p per mile
These r at es ar e also used f or mileage claims made on company car s.
I nput Tax: When t o Recover 499
Changes to VAT recovery on employee mileage claims
Business Br ief 22/ 05 explains t he new ar r angement s f or r ecover y of VAT on r oad f uel pur chased by employees. They wer e int r oduced as a r esult of t he j udgment of t he Eur opean Cour t (Case-33/ 03) in t he inf r act ion pr oceedings against t he Unit ed Kingdom, which was issued in Mar ch 2005. The new r ules came int o ef f ect f r om t he 1st January 2006.
The Gover nment has now int r oduced secondar y legislat ion t o comply wit h t he j udgment by r epealing t he Value Added Tax (I nput Tax) (Per son Supplied) Or der 1991 and r eplacing it wit h a new Or der t o be known as t he Value Added Tax (I nput Tax) (Road Fuel Pur chased By Employees) (Or der) 2005.
Under t he new Or der , employer s will be able t o cont inue t o t r eat as input t ax t he VAT incur r ed by t heir employees on f uel cost s t hat ar e subsequent ly r eimbur sed by t he employer , eit her on t he basis of t he act ual cost of t he f uel or by means of a mileage allowance. Unlike t he old Order, which t he ECJ f ound t o be incompat ible wit h t he Dir ect ive, t he new Order makes it explicit t hat employer s can r ecover only t hat VAT on f uel which is f or use in t heir businesses in making t axable supplies and must hold a VAT invoice in suppor t of t heir claim.
This means t hat t he old ar r angement s in pr act ice f or businesses t o r ecover VAT on f uel pur chased by employees ar e unchanged, except t hat businesses must now retain VAT invoices to support their claims. The invoice can be a f ull VAT invoice or a less det ailed VAT invoice, as appr opr iat e.
The only pr act ical change t o t he old syst em is t hat an invoice must be r et ained in suppor t of a claim f or VAT r ecover y - in t he vast maj or it y of cases, t his will be a less det ailed t ax invoice.
The change comes in f r om 1 J anuar y 2006 r egar dless of t he VAT r et ur n per iod end dat e. Fr om t hat dat e, employer s should r et ain VAT invoices, including less det ailed VAT invoices, t hat t heir employees obt ain f r om t he f uel supplier as pr oof of pur chase.
However , HMRC acknowledge t hat businesses will need a lit t le t ime t o make t he necessar y changes t o t heir ar r angement s in or der t o hold VAT invoices in suppor t of t heir claims. Ther ef or e, HMRC will be administ er ing t he change wit h a light t ouch unt il such t ime as businesses have had a r easonable per iod t o adj ust t o t he new r equir ement .
As wit h t he old syst em, input t ax may only be claimed on the cost of fuel for business use. As such, invoices only need t o cover t his amount .
HMRC accept t hat t he amount of t he invoice in many cases will not mat ch t he input t ax claim in r espect of business f uel in any one claim per iod and invoices may cover mor e t han one per iod, par t icular ly wher e f uel is pur chased t owar ds t he end of a per iod.
500 Principles of Business Taxat ion ‘Finance Act 2006’
Clear ly, a claim cannot be suppor t ed by a VAT invoice which is dat ed af t er t he dat es cover ed by t he claim. This means, in pr act ice, t hat it may be advisable f or employer s t o ar r ange f or t heir employees who use, or may use, t heir car s f or business pur poses t o r et ain all f uel invoices. This will ensur e t hat , at t he end of t he claim per iod, t he value of business f uel is cover ed by an invoice.
Illustration
Max wor ks f or Canmor e Limit ed. On a r ecent business t r ip Max dr ove 300 miles in his own Mer cedes E280 CDI . I n line wit h company guidelines he submit s a mileage claim f or £ 120 (300 miles at 40p).
The f uel element of t he claim amount s t o £ 42. This is 300 miles at t he diesel rat e of 14p f or t his 2,800 cc car.
I n or der f or t he company t o r ecover 7/47 of £ 42, Max must ensur e t hat a pet r ol r eceipt f or at least £ 42 accompanies t he mileage claim he submit t ed t o his employer . The pet r ol r eceipt must pre-dat e t he business t r ip and can be a nor mal r et ailer s invoice f r om a gar age.
Pre r egist r at ion input t ax
The condit ion says t hat t he supply must be made t o t he t axable per son who was a t axable per son at t he t ime of t he supply. However t her e is an except ion t o t his r ule t o enable pre-registration input tax t o be r ecover ed on a t r ader ’s f ir st VAT Ret ur n. The legislat ion st at es t hat f or goods acquired f or t he business and still owned at the date of registration and f or services supplied for the purpose of the business in the six months prior to registration, input t ax on SI 1995/ 2518 bot h of t hose it ems can be recovered on a trader’s very first VAT return once Reg. 111 he has r egist er ed f or VAT. A similar r ule applies t o input t ax on goods and ser vices used f or business pur poses by a company pr ior t o it s incor por at ion pr ovided t he per son who incur r ed t he expendit ur e becomes an of f icer or employee of t hat company and is f ully r eimbur sed by t he company f or t he expendit ur e. This is called pr e-incor por at ion input t ax.
Wher e t he t ax point on pur chase ar ises post r egist r at ion but t he goods ar e consumed or sold on pr e r egist r at ion t he t r ader will not have a valid input r eclaim. To be ‘input t ax’ t he goods must be consumed or supplied at a t ime when t he t r ader is a t axable per son (Schemepanel Tr ading Co. Lt d). The pr e- r egist r at ion r ules would not be in point as t he t ax point ar ose post r egist r at ion. Hence Schemepanel is r equir ed t o r est r ict input r ecover y in t his inst ance.
Anot her special r ule says t hat cr edit f or input t ax may be available in r espect of cer t ain post -der egist r at ion supplies. So wher e ser vices ar e supplied af t er t he SI 1995/ 2518 dat e of der egist r at ion, but t hose ser vices r elat e t o t axable supplies t hat wer e Reg. 111 made when t he t r ader was st ill VAT r egister ed, t he input t ax on t hose ser vices is r ecover able if a claim is made.
I nput Tax: When t o Recover 501
E10a.4 Supply for Business purposes
Ther e is no def init ion of whet her goods or ser vices have been supplied f or t he “pur pose of t he business”. Wher e t he connect ion bet ween t he expendit ur e and t he business is not clear , t he f ollowing t est s can be applied:
a) Det er mine t he int ent ion of t he per son at t he t ime of incur r ing t he expendit ur e. This is a subj ect ive t est and wher e t her e is no obvious associat ion bet ween t he business and t he expendit ur e concer ned, t he cour t should appr oach any asser t ion t hat it is f or t he business wit h cir cumspect ion and car e, I an Flockt on Development s 1987.
b) Est ablish whet her or not t her e is a clear connect ion bet ween t he act ual or int ended use of t he goods or ser vices and t he act ivit ies business. This s. 24(1) is an obj ect ive t est of t he use t o which t he goods ar e put
Expendit ur e, even if f or t he benef it of t he business is not necessar ily f or t he pur pose of t he business. I n t he case of Rosner (1993), VAT on legal cost s incur r ed in def ending a sole t r ader against cr iminal char ges was held t o be non- deduct ible under t his pr inciple. The same decision was r eached wher e a dir ect or was being def ended in t he case of Wallman Foods Limit ed.
I n t he case of P&O Eur opean Fer r ies (Dover ) Lt d, VAT on legal cost s in def ending t he company and cer t ain of it s employees char ged wit h manslaught er f ollowing t he sinking of a f er r y was held t o be deduct ible. I t had clearly been incur r ed f or t he pur pose of t he business even t hough it also had t he ef f ect of benef it ing individual employees.
I f a supply is pur chased which is used par t ly f or business pur poses and par t ly f or
non-business pur poses, t hen t he input t ax on t he supply has t o be appor t ioned
and only t he input t ax which r elat es t o t he business pur pose is available f or s. 24(5) cr edit . For example, you might have t o appor t ion input t ax on t elephone bills, wher e t he t elephone is used bot h f or business and f or pr ivat e use.
The appor t ionment pr ovisions of VATA 1994, s 24(5) wer e called int o quest ion by t he r uling in Lennar t z v Finanzamt Munchen I I I . The Cour t r uled t hat wher e goods ar e acquir ed solely f or a pr ivat e or non-business pur pose, VAT incur r ed is not r ecover able, even if t he goods in quest ion ar e lat er put t o a deduct ible business use (because t he r ight t o deduct VAT ar ises, and is exer cisable, at t he t ime when t he VAT is incur r ed). I f , however , a t axable per son acquir es goods and used t hem par t ly f or business pur poses and par t ly f or pr ivat e or non-business pur poses, he has a r ight t o t ot al and immediat e input t ax deduct ion (unless t he goods ar e subj ect t o input t ax r est r ict ion). Wher e t he goods ar e lat er used f or pr ivat e or non-business pur poses, t hat use is t o be t r eat ed as a t axable supply of ser vices and VAT must be account ed f or under VATA 1994, Sch 4 para 5(4) in each VAT per iod in which pr ivat e or non-business use of t he asset occur s. Recor ds must be kept showing how t he r elevant asset has been used. Typically t hese pr ovisions might apply t o yacht s, helicopt er s or aer oplanes bought by t he business.
502 Principles of Business Taxat ion ‘Finance Act 2006’
E10a.5 Claimant holds required evidence
This condit ion st at es t hat input t ax is available f or credit if t he required evidence is available. The r equir ed evidence t akes sever al f or ms. The most s. 24(6) SI common form is a tax invoice f or t he supplies t hat have been pur chased f r om 1995/ 2518 anot her t axable per son and a t ax invoice has t o sat isf y cer t ain condit ions Reg 29 (cover ed in t he chapt er on VAT r ecor ds).
An invoice is required from a foreign supplier f or t he ser vices t hat ar e r eceived f r om over seas. These ar e t he sor t s of ser vices t o which t he r ever se char ge under s.8 VATA 1994 applies.
For imported goods a certificate C79, which is issued mont hly by Cust oms t o all VAT r egist er ed impor t er s, will be t he necessar y evidence r equir ed.
If goods have been acquired from an EC member state t hen t he evidence required is what ever relevant document is required by t hat EC st at e. I n t he UK t he r elevant document is t he tax invoice. The r elevant document f r om t he EC st at e should show the claimant and the supplier’s VAT numbers, t he consideration excluding VAT t hat was paid f or t he goods and a description of the goods.
Cust oms can accept ot her document ar y evidence as t he r equir ed evidence but t his is at t heir discret ion.
Ther e is an except ion f r om t he main r ule in cer t ain cir cumst ances. A t ax invoice is not r equir ed as evidence when claiming a credit f or input t ax if t he expendit ur e was below £ 25 on:
• t elephone calls f r om public and pr ivat e t elephones;
• pur chases t hr ough coin-oper at ed machines;
• car par k char ges.
I n cer t ain sect or s t r ader s will be r equir ed t o pr ovide a higher st andar d of pr oof ; evidence will also be r equir ed t hat t he t ransact ion is bona f ide, bef or e input t ax incur r ed can be r ecover ed.
The r ule af f ect s t he f ollowing sect or s:
• Comput er s and r elat ed equipment ; • Telephones and r elat ed equipment ; • Alcohol pr oduct s, and • Oils held out as r oad f uel.
Essent ially, t he measur e will ensur e t hat any supply made on or af t er 16 Apr il 2003 will have t he input t ax disallowed if t he VAT invoice pr oves t o be invalid, and t he f ur t her evidence of bona f ides is not available.
I nput Tax: When t o Recover 503
Example 1
Dr aw a line t o mat ch t he pur chase t o t he “r equir ed evidence”
A pur chase of 100 pens f r om Certif icate C79 a UK st at ioner
The ser vices of an account ant Fr ench T.V.A invoice based in J er sey
I mpor t ed boxes f r om t he Tax invoice USA
Pur chase of 1,000 pencils Fee invoice f r om Fr ench supplier
E10a.6 Input tax was correctly charged
Credit f or input tax is restricted to the amount pr oper ly char geable on a supply. I f VAT was incor r ect ly char ged on a supply t hat VAT cannot be r ecover ed as s. 24(1) and (2) input t ax. The classic example is wher e a business is t r ansf er r ed as a going concer n (TOGC). A TOGC is a supply which is out side t he scope of VAT – so it is not a VAT supply. Hence, if VAT was mist akenly char ged on such a supply it would gener ally not be possible t o r ecover t his VAT as input t ax.
One can only r ecover t he cor r ect amount of tax that should have been charged so if t he t ax char ged was over st at ed, t he credit f or input tax is restricted to t he amount t hat should have been charged. I nput t ax can only be recovered at t he cor r ect amount on a cor r ect t ype of supply.
E10a.7 Direct and immediate link with a taxable transaction
The f inal condit ion is t hat t he goods or t he ser vices pur chased must have a dir ect and immediat e link wit h a t axable t r ansact ion.
The Eur opean Cour t of J ust ice gave an impor t ant r uling on t his linking pr inciple in t he case CCE v Midland Bank Plc (2000). The issue in t his case was whet her one of t he Bank’s subsidiar ies could r ecover input t ax char ged on legal ser vices incur r ed when it was def ending it self against a legal act ion ar ising f r om an earlier t axable t r ansact ion. Cust oms did not disput e t hat t he VAT incur r ed was input t ax f or t he Bank but ar gued t hat t he Bank should t r eat t he input t ax as r elat ing t o a gener al over head and, hence, t her e would be some r est r ict ion in t he input t ax r ecover y because t he Bank as a whole was par t ially exempt .
504 Principles of Business Taxat ion ‘Finance Act 2006’
The Eur opean Cour t of J ust ice made it s j udgement in f avour of Customs. VAT paid on legal ser vices supplied t o a Bank, which was making bot h t axable and exempt supplies, in connect ion wit h a claim f or damages ar ising out of an earlier t axable t r ansact ion, did not have t he necessar y dir ect and immediat e link wit h t hat t axable t r ansact ion. Hence, input t ax could not be r ecover ed in f ull.
To be directly attributable to making a supply an input has t o be a cost component of t hat supply at the time it is made.
The Eur opean Cour t of J ust ice’s decision in t he BLP Group plc v CCE (1995) case also looked at t his condit ion in some det ail. I n t his case, input t ax t hat was dir ect ly linked t o making an exempt supply (sale of shar es) had t o be at t r ibut ed t o t hat exempt supply and hence was ir r ecover able input t ax even t hough t he wider pur pose of an exempt shar e sale was t o benef it t he r est of a wholly t axable business. I nput t ax has t o at t ach t o t he immediat e supply and not t o t he wider pur pose.
E10a.8 Blocked input tax
I n cer t ain cases input t ax is specif ically ir r ecover able. The blocking or der SI includes input t ax on business entertaining and motor cars – input t ax can never 1992/ 3222 be r ecover ed on t hese it ems even if t he t r ader meet s all t he condit ions out lined in t his chapt er.
‘Business ent er t ainment ’ means ent er t ainment (including hospit alit y of any kind) provided by a t axable person in connect ion wit h a business carried on by him, but does not include t he pr ovision of any such ent er t ainment f or eit her or bot h
• employees of t he t axable per son; or • if t he t axable per son is a company, it s dir ect or s or per sons engaged in t he management of t he company
unless t he pr ovision of ent er t ainment f or such per sons is incident al t o it s SI 1992/ 3222 pr ovision f or ot her s. Art 5(3)
Cust oms r egar d business ent er t ainment as including
• pr ovision of f ood and dr ink; • pr ovision of accommodat ion (hot els, et c.); • pr ovision of t heat r e and concer t t icket s; • ent r y t o spor t ing event s and f acilit ies; • ent r y t o clubs, night clubs, et c; and • use of capit al goods such as yacht s and air cr af t f or t he pur pose of ent er t aining.
Wher e t he cost of pr oviding hospit alit y is passed on as par t of t he over all char ge f or a t axable supply, VAT incur r ed in pr oviding t he hospit alit y cannot be r eclaimed.
I nput Tax: When t o Recover 505
For business ent er t ainment pur poses, Cust oms r egar d ‘employee’ as including
• dir ect or s or anyone engaged in t he management of t he business (including par t ner s); • self -employed per sons (subsist ence expenses only) treated by the employer in t he same way f or subsist ence pur poses as an employee; and • helper s, st ewar ds and ot her people essent ial t o t he r unning of spor t ing or similar event s but not as including pensioner s and f or mer employees, j ob applicant s and VAT Not ice int er viewees, and shar eholder s (who ar e not also employees). 700/ 65/ 02 par as 2.3, 2.4
Staff entertainment. Following t he decision in Er nst & Young, Cust oms accept t hat wher e an employer pr ovides ent er t ainment f or t he benef it of it s employees (e.g. t o r ewar d t hem f or good wor k or t o maint ain and impr ove st af f mor ale), it does so wholly f or business pur poses. Thus, t he VAT incur r ed on ent er t ainment of employees (e.g. st af f par t ies, t eam building exer cises, st af f out ings and similar event s) is input t ax and is not blocked f r om r ecover y under t he business ent er t ainment r ules. Ther e ar e t wo except ions t o t his gener al r ule.
• Wher e ent er t ainment is pr ovided only f or dir ect or s, par t ner s or sole pr opr iet or s of a business, t he VAT incur r ed is not input t ax as t he goods or ser vices ar e not used f or a business pur pose. But wher e dir ect or s, et c. at t end st af f par t ies t oget her wit h ot her employees, Cust oms accept t hat t he VAT incur r ed is input t ax and is not blocked f r om r ecover y.
• Wher e employees act as host s t o non-employees, t he cost s ar e incur r ed VAT Not ice solely f or t he pur pose of ent er t aining t he non-employees and t he input 700/ 65/ 02 par as 3.1-3.3 t ax is blocked under t he business ent er t ainment r ules.
Subsistence expenses. Wher e meals et c. ar e pr ovided away f r om t he place of VAT Not ice wor k on a business t r ip, t he VAT incur r ed on t he employee’s meal can be claimed 700/ 65/ 02 par as 2.5 as input t ax under t he subsist ence r ules.
Staff parties with guests, etc. Wher e a business ent er t ains bot h employees and non-employees, it can only r ecover as input t ax t he VAT it incur s on ent er t aining it s employees. The por t ion of t he input t ax incur r ed in ent er t aining ot her s is blocked under t he business ent er t ainment r ules. I n KPMG (No 2) an VAT Not ice account ancy f ir m or ganised dinner dances f or it s employees, each of whom was 700/ 65/ 02 ent it led t o br ing one guest . I t was held t hat t he r elat ed input t ax should be par as 3.4 appor t ioned on t he basis t hat t he pr opor t ion of t he expendit ur e at t r ibut able t o t he guest s const it ut ed business ent er t ainment . The ent er t ainment of t he non- employees could not be t r eat ed as incident al t o t he ent er t ainment of t he employees. This decision came af t er t he decision in Thor n EMI plc v C & E Commr s, CA [1995] t hat input t ax r elat ing t o business ent er t ainment can be appor t ioned. The decision in KPMG (No 2) was dist inguished in Er nst & Young wher e a char ge of £ 15 per head was made f or guest s. The t r ibunal held t hat t he cr ucial char act er ist ic of ‘ent er t ainment ’ in t he phr ase ‘business ent er t ainment ’ was t hat it was pr ovided f r ee of char ge. Alt hough t he £ 15 char ge was
506 Principles of Business Taxat ion ‘Finance Act 2006’
consider ably less t han t he cost of t he par t y, it was not so small as t o say t he meal was pr ovided f r ee of char ge. Hence Er nst & Young account ed f or out put VAT on t he £ 15 and had f ull r ecover y of r elat ed input t ax.
I n Thor n EMI plc v C & E Commr s, [1995], Cust oms sought t o exclude cr edit f or VAT Not ice all input t ax on hospit alit y chalet s const r uct ed t o r eceive cust omer s at shows 700/ 65/ 02 par as 2.6 alt hough accept ing t hat t he chalet s wer e used par t ly f or business pur poses. I t was held, t hat Cust om’s appr oach was unr easonable. Applying t he gener al pr inciple in EC 6t h Direct ive, Art 17, appor t ionment should be allowed. Cust oms now accept t his.
I n 2005 t he boxing pr omot or , Fr ank War r en, won a case which enabled him t o r ecover 25% of t he input t ax on a hospit alit y box on t he basis t hat t his element was pr omot ional.
Motor cars. Apar t f r om one or t wo except ions, VAT cannot be r ecover ed on t he pur chase of a mot or car .
One of t he except ions is on t he pur chase of a mot or car wher e exclusive business use is intended. This condit ion will not be sat isf ied wher e t he t axable per son int ends t o make t he car available t o any per son f or private use. Cust oms r egar d a car as being used exclusively f or a business pur pose if it is used only f or business j our neys and it is not available f or pr ivat e use.
I n Upt on (t / a Fagomat ic) v C & E Commr s (2002) a t r ader r eclaimed input t ax on t he pur chase of a Lambor ghini. The t r ibunal allowed t he t r ader ’s appeal, as all t he shops which t he t r ader visit ed wer e wit hin walking dist ance of his home and he always used t axis t o at t end social engagement s. The High Cour t , however , r ever sed t he decision holding t hat , on t he evidence, t he t r ader had made t he car available for private use. The f act t hat t he t ribunal had accept ed t he t rader ’s evidence t hat he did not need t o use t he car pr ivat ely was not conclusive.
The Cour t of Appeal upheld t his decision. The “int ent ion t o use” is not synonymous wit h t he “int ent ion t o make available”. Wher e an individual t r ader acquir es a car , t he ver y f act of his deliber at e acquisit ion of t he car , wher eby he makes himself t he owner of t he car and cont r oller of it , means t hat he must int end t o make it available t o himself f or pr ivat e use, even if he never int ends t o use it pr ivat ely.
Fagomat ic is of t en r ef er r ed t o when consider ing t he r ecover abilit y of input t ax on car s. Her e is a select ion of r elevant cases.
A couple owned and oper at ed a hot el. The husband bought a Toyot a Previa and r eclaimed t he input t ax. Cust oms disallowed it , on t he grounds t hat Art 7(2G) SI 1992/ 3222 r uled out t he assumpt ion of 100% business use. The Tr ibunal held t hat , on t he evidence, t he t r ader had shown t hat he had no int ent ion of using t he car pr ivat ely or of making it available f or pr ivat e use.
I nput Tax: When t o Recover 507
The High Cour t has over r uled t his decision, holding t hat t he Tr ibunal chair man had er r ed in law. The Cour t of Appeal’s decision in Fagomat ic est ablished t hat t he t est of “int ent ion t o use” was subject to the f urther condition that “there must be no int ent ion t o make available f or pr ivat e use”. I f t he t r ader has placed no physical or legal r est r ict ion on t he possibilit y of making pr ivat e use of t he car , t her e was assumed t o be an int ent ion t o make it available f or pr ivat e use, even if t her e was no int ent ion t o t ake advant age of t hat availabilit y, C & E v PJ Robbins.
The Tr ibunal has conf ir med in anot her case t hat a t r ader could not r ecover t he input t ax on a car , in spit e of accept ing t hat he made no privat e use of it (having anot her car f or all pr ivat e mot or ing). The Tr ibunal applied t he r ulings of t he Cour t of Appeal in Fagomot ic, Robbins, J Williams (t / a Radmor e Coaches)
Anot her r ecent case shows how har d it is f or t he t axpayer t o convince t he Tr ibunal t hat a car is not available f or pr ivat e use. The t r ader bought an I suzu Tr ooper est at e car t o t ow a t r ailer (which t r anspor t ed high-value cars). The mileage was 180,000 on business over t wo year s. The Tr ooper was usually kept at a f ar m 8 miles f r om t he t r ader ’s house, but it occasionally spent t he night at t he house (wit h t he t railer at t ached) if t he t r ader was due t o t r avel in t he ot her dir ect ion ear ly in t he mor ning. Somet imes it was dr iven by sub-cont r act or s, in which case it was always r et ur ned t o t he f ar m.
The insur ance policy was t he st andar d one which allows pr ivat e as well as business use. Alt hough t he keys t o t he vehicle wer e kept at t he f ar m, t he t r ader had a spar e set at home. The t r ader had a dif f er ent car (and his wif e a t hir d) f or pr ivat e mileage of about 15,000 miles a year .
The Tribunal held t hat t he t rader had f ailed t o sat isf y t he ext r emely st r ingent t est s laid down by t he Cour t of Appeal in Fagomat ic. The car was act ually available f or pr ivat e use, and he was deemed t o have int ended t hat ; t hat was enough t o block t he input t ax, DC Humphr eys
An account ant r eclaimed input t ax on t he pur chase of six car s bet ween Mar ch 1997 and Sept ember 1998. Thr ee of t he car s wer e sold in t he same per iod, and he account ed f or out put t ax on t he sales. He argued t hat he had ot her cars f or his pr ivat e use, and t hese car s wer e solely int ended f or business use.
The Tr ibunal held t hat t he Fagomat ic pr inciple applied – t he car s wer e act ually available f or pr ivat e use, and t his was enough t o deny t he input t ax cr edit , HAS Thompson (t / a HAS Thompson & Co)
On t he ot her hand, a company has succeeded bef or e t he Tr ibunal wit h t he ar gument t hat t he company’s boar d of dir ect or s had passed a r esolut ion f or bidding pr ivat e use of t he car . The car was f or t he business use of t he managing dir ect or , who was not a shar eholder (alt hough par t of t he cont r olling f amily). He lived only 50 yar ds f r om t he business pr emises, Elm Milk Lt d. This decision was conf ir med in t he Cour t of Appeal in 2006.
508 Principles of Business Taxat ion ‘Finance Act 2006’
Anot her company has also succeeded on t he basis of an int ent ion f or car s only t o be available f or business use. Secur it y guar ds t ook t he car s home, but t hey wer e st ill on dut y, and t he car s could be collect ed by t he company at any t ime. The employees all had t heir own car s which wer e used f or pr ivat e mot or ing.
Cust oms r elied on a t er m in t he employees’ cont r act s which st at ed t hat pr ivat e use of t he car s r equir ed special per mission – implying t hat pr ivat e use was cont emplat ed – but t he Tr ibunal did not believe t hat t his accur at ely r ef lect ed t he int ent ions of t he t axpayer . The cont r act s wer e st andar d f or ms which had been pur chased f r om t he local Chamber of Commer ce, and t he t axpayer had not consider ed t he ef f ect of t his t er m on VAT r ecover y.
The Tr ibunal allowed t he input t ax, Mast er guar d Secur it y Ser vices Lt d
I t is not able t hat t he cases wher e t he t r ader has been successf ul involve companies. I t is f ar easier t o r est r ict int ended usage t hr ough a company as it is a separ at e legal ent it y t o t he owner / manager of t he business.
Example 2
Fill in t he missing wor ds:
The condit ions t o be sat isf ied f or an input t ax claim ar e:
1. A supply of ………….. or ser vices has been made.
2. A supply was made t o t he …………… ……………….
3. The supply was f or a ……………… pur pose.
4. The claimant holds t he r equir ed ……………….
5. …………… t ax has been cor r ect ly char ged.
6. Goods/ ser vices have a ……………… and ………………… link wit h a t axable t r ansact ion.
I nput Tax: When t o Recover 509
Answer 1
A pur chase of 100 pens f r om Certif icate C79 a UK st at ioner
The ser vices of an account ant Fr ench T.V.A invoice based in J er sey
I mpor t ed boxes f r om t he Tax invoice USA
Pur chase of 1,000 pencils Fee invoice f r om Fr ench supplier
Answer 2
The condit ions t o be sat isf ied f or an input t ax claim ar e:
1. A supply of goods or ser vices has been made.
2. A supply was made t o t he t axable per son.
3. The supply was f or a business pur pose.
4. The claimant holds t he r equir ed evidence.
5. I nput t ax has been cor r ect ly char ged.
6. Goods/ ser vices have a dir ect and immediat e link wit h a t axable t ransact ion.
510 Principles of Business Taxat ion ‘Finance Act 2006’
SUMMARY – INPUT TAX: WHEN TO RECOVER
Ther e ar e numer ous condit ions which have t o be sat isf ied bef or e input t ax is available f or credit .
Fir st ly a supply of goods or ser vices must have act ually t aken place.
Secondly t hat supply must have been made t o a t axable per son. That t axable per son must have been a t axable per son at t he t ime of t he supply. Ther e ar e however some except ions t o t his r ule including pr e-r egistr at ion input t ax and pr e-incor por at ion input t ax.
The goods and ser vices must be used f or a business pur poses if input t ax cr edit is t o be allowed.
The claimant must hold t he r equir ed evidence t hat input t ax has been incur r ed. The most common evidence a business will hold is a VAT invoice pr ovided by t he supplier of t he goods or ser vices.
Credit f or input tax is restricted to the amount properly chargeable on a supply. I f VAT was incor r ect ly char ged on t he supply t hen t hat VAT cannot be r ecover ed as input t ax.
The f inal condit ion r equir ed t o be sat isf ied is t hat t he goods or t he ser vices pur chased must have a dir ect and immediate link wit h a t axable t r ansact ion.
All t he above ar e subj ect t o t he except ions det ailed in t he gener al blocking pr ovisions in SI 1992/ 3222.
E10b: PARTIAL EXEMPTION
I n t his chapt er you will look at : par t ial exempt ion, wher e a business makes bot h t axable and exempt supplies; det er mining t he amount of input t ax t hat t he business can r ecover ; t he appor t ionment of input VAT; t he de minimis input VAT limit s; t he annual adj ust ment r equir ed by par t ially exempt businesses; input t ax at t r ibut ion; adj ust ment s t o input r ecover y f or changes in int ended supplies; t he special met hods of appor t ionment available t o businesses.
10b.1 Introduction
A par t ially exempt business is simply a business which supplies t axable and exempt sales, i.e. part of its business is taxable and part of it is exempt. This could be a f ir m of business adviser s. Par t of what t hey do is consult ancy ser vices and t hey may also pr ovide insur ance ser vices. The consult ancy ser vices will be t axable, t he insur ance ser vices exempt . The issue wit h par t ially exempt businesses is how much input t ax t hey can r eclaim.
The amount of allowable input t ax f or which a t axable per son is ent it led t o claim at t he end of any per iod is so much of t he input t ax on supplies, acquisit ions and impor t at ions in t he per iod as is allowable as being at t r ibut able t o t he f ollowing supplies made, or t o be made, by t he t axable per son in t he cour se or f ur t her ance of his business.
(a) ‘Taxable supplies’, i.e. supplies of goods and ser vices made in t he UK ot her t han exempt supplies. SI 1995/ 2518 Reg 101(1) (b) Supplies out side t he UK which would be t axable supplies if made in t he
UK. SI 1995/ 2518 Reg 103(1)a (c) Supplies of ser vices which SI 1995/ 2518
(i) ar e supplied t o a per son who belongs out side t he EC, or (ii) are directly linked to the expor t of goods t o a place out side t he EC, or (iii) consist of t he pr ovision of int er mediar y ser vices in r elat ion t o any t r ansact ion wit hin (i) or (ii) above
pr ovided t hat t he supply is exempt (or would have been exempt if made in t he UK) by virt ue of VATA 1994, Sch 9 Group 2 (insur ance) or VATA 1994, Sch 9 Group 5 I t ems 1–8 (f inance).
(d) Supplies made eit her in or out side t he UK which f all, or would f all, wit hin VATA 1994, Sch 9 Group 15 it em 1 or 2 (invest ment gold).
512 Principles of Business Taxat ion ‘Finance Act 2006’
Cust oms must make r egulat ions f or secur ing a f air and r easonable s 4(2), 26 at t r ibut ion of input t ax t o t he supplies wit hin (a) t o (c) above.
Illustration 1
ABC Limit ed is par t ially exempt , i.e. some of t he company’s t ur nover is st andar d r at ed and some is exempt .
Taxable t ur nover Exempt t ur nover £ 100,000 £ 20,000
Input tax
£15,000 £5,000 £3,000