2.1 Corporate income tax & Capital taxes

Question 1

Standard pro forma to calculate corporate income tax

Answer 1

Accounting profit
LESS: Income exempt from tax or taxed under other rules
ADD: Disallowable expenses
ADD: Accounting depreciation
LESS: Tax depreciation allowance
= Taxable trading profit

Question 2

The accounting profit

Answer 2

is the profit before tax shown in the statement of profit or loss in the annual financial statements

Question 3

Income exempt from tax or taxed under other rules

Answer 3

is any income included in the accounting profit which
- does not relate to the main trading activity, ie. rental income, dividend income, interest receivable
- may be taxed under other rules
- or income exempt from taxation under that particular countrys rules

Question 4

Disallowable expenses

Answer 4

are expenses that have been deducted from accounting profit, ie. they are allowable under accounting standards, but for tax purposes can’t be claimed
- Egs in UK: entertaining customers, gift aid payments and political donations

Question 5

Accounting depreciation

Answer 5

is added back because it is an accounting entry that is not allowed for tax purposes because it is too subjective (ie. you can choose the way to depreciate assets)
- it is replaced with tax depreciation allowance

Question 6

Tax depreciation allowance

Answer 6

is a form of depreciation that is allowable for tax purposes on certain items of capital expenditure
- aka capital allowances or tax depreciation
- it is often given on a reducing balance basis
- a full years tax depreciation allowance is given if asset is owned at accounting date regardless of when it was purchased (ie. no apportionment for part year)
- tax depreciation allowances are not normally given in year of disposal of asset - replaced by balancing allowances and charges

Question 7

Balancing allowances and charges

Answer 7

When an asset is sold any accounting profit or loss must be disallowed for tax purposes and replaced with the tax equivalent known as a balancing allowance or charge
- A balancing allowance (BA) = a tax loss on disposal
- A balancing charge (BC) = a tax profit on disposal

Question 8

The tax pro forma can be expanded to include the effect of the asset disposal

Answer 8

Accounting profit
LESS: Income exempt from tax or taxed under other rules
ADD: Disallowable expenses
ADD: Accounting depreciation
ADD: Accounting loss on disposal of an asset
LESS: Accounting profit on disposal of an asset
LESS: Tax depreciation allowance
ADD: Tax profit on disposal of an asset (BC)
LESS: Tax loss on disposal of an asset (BA)
= Taxable trading profit

Question 9

For accounting purposes when an asset is disposed of the accounting profit or loss is calculated by

Answer 9

Proceeds
LESS: Carrying amount (Statement of financial position)
= Accounting profit / (loss)

Question 10

For tax purposes when an asset is disposed of the balancing allowance or charge is calculated by

Answer 10

Proceeds
LESS: Tax written down value (TWDV)
= Balancing charge / (allowance)

Question 11

Trading losses

Answer 11

When an entity makes a trading loss the assessment for that tax year will be nil
- The entity can then claim loss relief based on rules of the country

Question 12

Possible ways of relieving a trading loss are

Answer 12

• Carry losses forward against future profits of the same trade
• Carry losses backwards against previous periods
• Offset losses against group company profits
• Offset losses against capital gains in the same period

Question 13

Trading losses on cessation of business

Answer 13

If an entity ceases to trade, most countries will allow them to carry back a loss against profits of previous years to generate a tax refund
- In the UK this is called Terminal Loss Relief and enables the loss to be carried back three years.

Question 14

Capital tax gains

Answer 14

are gains made on the disposal of investments and other non current assets
- most common assets taxed are listed stocks, shares and property
- In the UK it is called Capital Gains Tax

Question 15

The standard pro forma for capital tax gains

Answer 15

Proceeds
LESS: Costs to sell the asset
= Net proceeds
LESS: Cost of original purchase cost of asset
LESS: Costs incurred to purchase the asset
LESS: Enhancement costs to the asset
LESS: Indexation allowance
= Chargeable gain

Question 16

Costs that can be deducted from proceeds of asset disposal are

Answer 16

• Original purchase cost of the asset
• Costs incurred to buy the asset, eg: legal fees, estate agent fees
• Costs incurred to sell the asset, eg: legal fees, estate agent fees
• Enhancement / improvement costs of the asset, eg: extension to existing asset
• Indexation allowance - adjustment made for inflation calculated on all allowable costs up to disposal date

Question 17

Types of assets exempt from capital tax (UK)

Answer 17

• Qualifying corporate bonds
• Private motor vehicles
• Chattels sold for less than £6000 (tangible movable property)
• Wasting chattels (boats and animals)

Question 18

Types of disposals exempt from capital tax (UK)

Answer 18

• gifts to charities or certain assets such as works of art
• gifts to museums or government institutions

Question 19

Capital losses and how they can be relieved

Answer 19

Most countries keep capital losses separate from trading activities
Possible ways of relieving capital losses are:
- Carry forward against future capital gains (most countries)
- Carry back against previous capital gains
- Offset against taxable trading profit in the current period

Question 20

Rollover relief

Answer 20

In some countries gains may be postponed by using rollover relief
This enables an entity to postpone paying tax on a gain if it reinvests the same proceeds in a replacement asset until the replacement asset is sold