2.1 Corporate income tax & Capital taxes Flashcards
Standard pro forma to calculate corporate income tax
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
The accounting profit
is the profit before tax shown in the statement of profit or loss in the annual financial statements
Income exempt from tax or taxed under other rules
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
Disallowable expenses
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
Accounting depreciation
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
Tax depreciation allowance
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
Balancing allowances and charges
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
The tax pro forma can be expanded to include the effect of the asset disposal
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
For accounting purposes when an asset is disposed of the accounting profit or loss is calculated by
Proceeds
LESS: Carrying amount (Statement of financial position)
= Accounting profit / (loss)
For tax purposes when an asset is disposed of the balancing allowance or charge is calculated by
Proceeds
LESS: Tax written down value (TWDV)
= Balancing charge / (allowance)
Trading losses
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
Possible ways of relieving a trading loss are
- 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
Trading losses on cessation of business
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.
Capital tax gains
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
The standard pro forma for capital tax gains
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
Costs that can be deducted from proceeds of asset disposal are
- 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
Types of assets exempt from capital tax (UK)
- Qualifying corporate bonds
- Private motor vehicles
- Chattels sold for less than £6000 (tangible movable property)
- Wasting chattels (boats and animals)
Types of disposals exempt from capital tax (UK)
- gifts to charities or certain assets such as works of art
- gifts to museums or government institutions
Capital losses and how they can be relieved
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
Rollover relief
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