Chapter 7: Corporation Tax & VAT Flashcards
Introduction to Corporation Tax
Corporation Tax is payable on:
· all income profits and
· chargeable gains
· of a body corporate
· that arise in its accounting period.
The sum of a company’s profits and gains is known as ‘TTP’ (taxable total profits chargeable to corporation tax).
Reference to the financial year
Companies are assessed to corporation tax by reference to the financial year (1 April – 31 March). Note that because a company can choose its accounting period, it is often different to the financial year, which is the same for all companies.
Main rate for corporation tax
The amount of TTP will determine the amount of corporation tax payable.
The main rate of corporation tax for the 2024/2025 tax year is 25% for companies with TTP greater than £250,000. If a company’s TTP is £50,000 or less, the corporation tax rate is 19%. If a company’s TTP is over £50,000 and up to £250,000, a company may claim marginal relief which has a tapering effect on the tax rate. These are the same rates as the previous tax year.
Calculation of TTP - basic proforma
Chargeable gains
Sale proceeds
[Allowable Expenditure]
[Indexation Allowance]
[Capital/Trading Losses]
= Chargeable Gain
Income Profits
Income receipts
[Deductible Expenditure]
[Capital Allowances]
[Trading Losses]
= Income Profits
Income Profits
You have already looked at the nature of capital and income receipts. Income and capital receipts are subject to different tax rules, so it is necessary to identify the nature of the receipts. This is the case even though companies pay corporation tax at the same rates on income and gains.
Remember the basic rule that income receipts and expenditure arise through everyday trading whereas capital receipts and expenditure arise from one-off transactions.
Chargeable Income Receipts
Chargeable income receipts:Receipts of an income nature which arise from the business or trading activity (and which are not exempt receipts).
To calculate the taxable income profits, you must aggregate all chargeable income receipts and deduct all tax-deductible expenditure.
Income Receipts (What calculates a company’s income)
What constitutes a company’s income?
The most common types of company income are:
- rental income;
- trading income;
- interest (usually from bank savings accounts); and
- dividend income.
Note the following regarding dividends
- Dividends paid to UK companies are subject to corporation tax unless the dividend falls within one of a number of exemptions. However, the exemptions are very broad and the general effect of the rules is that all dividends are exempt from corporation tax unless certain anti-avoidance provisions apply.
- Dividend income received by a company is therefore generally exempt from corporation tax and is therefore not included in that company’s TTP for tax purposes. A company pays a dividend out of profits that have already been taxed so the tax already paid satisfies the recipient company’s tax liability in respect of the dividend.
- For the same reason, the dividend is not tax deductible for the company paying it.
Deductible Expenditure for Income Purposes
Tax deductible expenditure: Expenditure by a company that the company is permitted to deduct from its income receipts, thereby reducing its overall tax bill.
To be deductible for tax purposes the expenditure must:
- be ‘…wholly and exclusively’ incurred for the purposes of the trade – eg expenditure which is partially by way of gift will not be deductible but if expenditure was needed to produce an item for sale, such as raw materials, it would be;
Deductible Expenditure for Income Purposes
- not be prohibited by statute – eg business entertainment expenditure (i.e. money spent by a company entertaining its clients) and provisions made in accounts for doubtful debts as they are not yet bad debts that have been written off; and
- be of an income nature – eg rent, interest paid, wages, repairs.
Interest Payments
Interest paid on business loans will generally be a deductible income expense ie a company can deduct the amount of the interest it has paid from its profits to reduce the TTP and thereby reduce the overall tax bill.
Where a company (or group of companies) has more than £2 million of net interest expense in the UK any year, the amount of interest a company may deduct is restricted to, broadly, a maximum amount equal to 30% of its income receipts. This is known as the corporate interest restriction, or CIR.
Adjustments for Capital Allowances
Capital expenditure is generally only deductible from capital receipts and not usually deductible to calculate income profits. In addition, depreciation (an accounting concept) is not an allowable deduction for tax purposes and therefore to allow businesses to spread the cost of certain capital assets over a period of time, ‘capital allowances’ are given as a deduction against income receipts.
Capital Allowances
Even though capital allowances relate to capital expenditure, the allowances are treated as a deduction for income purposes in calculating income profits. Capital allowances are, therefore, tax reliefs available on qualifying items of expenditure.
Qualifying Expenditure
Qualifying expenditure includes expenditure incurred on plant and machinery. There are other special capital allowances that apply to, for example, long life assets, research and development expenditure and certain costs of construction and renovation of commercial buildings but these are outside the scope of the module.
Main Rate Capital Allowances
Companies can deduct 18% of the value of plant and machinery (‘P&M’) from their income receipts each year on a ‘reducing balance’ basis. This means that when a company claims capital allowances in one year on P&M, the value of the P&M for tax purposes is reduced by 18%. This value is referred to as the ‘tax written down value’ or ‘TWDV’ of the P&M. When the company claims capital allowances in the following year, it will claim 18% of the TWDV of the P&M after it has been reduced by the previous year’s capital allowances claim.
Example
if the TWDV of P&M is £100,000 then the capital allowances figure will be 18% of £100,000, which is £18,000, and the TWDV for the purposes of calculating next year’s capital allowances will be £82,000 (£100,000 - £18,000). It follows that next year’s capital allowances figure will be 18% of £82,000, which is £14,760.
Annual Investment Allowance
Another type of capital allowance is the annual investment allowance (‘AIA’). This enables a company (or unincorporated business) to deduct 100% of expenditure on new, used and refurbished P&M up to a specified amount. This is currently £1 million for any qualifying purchases in each year.
Annual Investment Allowance
The normal capital allowance of 18% can be applied to the balance of any expenditure above that amount. Therefore, if a company has spent more than £1 million in 2023 on P&M, the company is entitled to deduct from income profits the AIA of £1 million plus 18% of the balance of the expenditure. After the first year, the allowance reverts back to 18% per annum on a reducing balance basis.
Example
X Ltd spends £1,400,000 on plant and machinery in its accounting period ended 31 December 2024. It claims its full capital allowances for that year and the next year, as an income deduction. What is the tax written down value of the plant and machinery after the second year?
Year 1
Allowance Claimed
Annual investment allowance = £1,000,000 + 18% of reducing balance = £400,000
(18% x (£1,400,000-£1,000,000)). This comes to £72,000.
Total year 1 allowance = £1,072,000
TWDV
£328,000
(cost of £1,400,000 – Total year 1 allowance of £1,072,000)
(The company can claim (i) full AIA of £1 million plus (ii) the normal 18% allowance on the balance of the expenditure).
Year 2
Allowance Claimed
18% of Year 1 WDV = £328,000
(18% x £328,000). This comes to £59,040.
TWDV
£268,960
(Year 1 TWDV of £328,000 – Year 2 allowance of £59,040)
The company can claim the normal 18% allowance on the tax written down value of the asset at the end of Year 1.
Capital allowance: Full expensing (companies only)
From the 1 April 2023 until 31 March 2026, a new capital allowance was introduced by the government. This new allowance allows companies only to deduct 100% of the cost of new and unused plant and machinery. The amount deductible is uncapped. Full expensing is a first year allowance meaning that a claim must be made in the period in which the expenditure on the plant and machinery is incurred.
Capital Allowances: Super-deduction
In response to the Covid-19 pandemic, the government introduced a temporary capital allowance which allowed companies to claim 130% first-year relief on expenditure incurred from 1 April 2021 until 31 March 2023 on qualifying plant and machinery.
Capital Allowances: Super-deduction
The Super-deduction allowance did not apply to second-hand, used or leased assets. It included expenditure on assets such as fire alarm systems, security systems, bathroom sanitaryware, carpets, computers equipment and servers, tractors, lorries and vans, ladders, drills and cranes, office desks and furniture, refrigeration units and electric vehicle charging points. Unlike the AIA, there was no expenditure limit on the super-deduction allowance. We will not consider this further as it is no longer available, although an example follows to illustrate how it operated.
Capital Allowance - Super Deduction
Example: B Ltd spent £2,000,000 on qualifying plant and machinery in its accounting period ended 31 March 2023. It could claim the super-deduction allowance of 130% relief on the expenditure. This means B Ltd could deduct £2,600,000 in calculating its taxable profits in Year 1.
Trading Losses
It is possible for corporation tax purposes, for companies to offset profits with trading losses. This will be covered later in the element.
Chargeable Gains
Reminder: the calculation for chargeable gains is as follows:
Sale proceeds less:
- (Allowable expenditure)
- (Indexation allowance)
- (Capital/trading losses)
Sale Proceeds: sale proceeds arise where a company sells a capital asset, for example, a piece of land or some machinery.
Allowable Expenditure
The same rules apply in relation to allowable expenditure for chargeable disposals by companies as for individuals (ie initial expenditure, subsequent expenditure (such as costs of defending title and enhancement expenditure) and costs of disposal can be deducted). But note the following differences between companies and individuals:
- There is no annual exemption for companies.
- Indexation allowance continues to be available for companies but is frozen up to 31 December 2017.
Substantial Shareholding Exemption
- The Substantial Shareholding Exemption, or SSE, is a relief that can exempt from corporation tax the whole of a chargeable gain that arises when a company disposes of shares in a trading company (or the holding company of a trading group) provided certain conditions are met.
The disposing company must have held at least 10% of the ordinary share capital of the company whose shares are being disposed of for at least 12 consecutive months in the last six years. This relief is not available for individual sellers BUT Companies cannot reduce the tax they pay on their chargeable gains by claiming Business Asset Disposal Relief or Investors’ Relief.
Trading and Capital Losses
- A company can use trading and capital losses to offset gains to reduce the corporation tax liability. This will be covered later in the element.
Rollover relief for replacement of business assets (‘Rollover Relief’)
This relief is a tax deferral mechanism, which can be used by individuals or companies to defer tax that would otherwise be due in respect of a gain arising when an asset is disposed of. You were introduced to this relief earlier.
It will potentially be available in the following situations:
- where a company disposes of a qualifying business asset and it (or a company in its group) buys another qualifying asset (referred to as the ‘replacement asset’);
- where a sole trader or partnership disposes of a qualifying business asset and buys another qualifying asset;
- where an individual, other than a sole trader, owns a business asset, sells that asset and buys another qualifying asset and both assets are used by either:
- a company which is the individual’s personal company; or
- a partnership of which the individual is a partner.
Replacement Asset
Note that although the new asset is referred to as the ‘replacement asset’, it does not have to be the same type of asset as the asset which has been disposed of.
General effect of the relief
The gain from a disposal of a qualifying asset is carried forward and ‘rolled’ into the acquisition cost of a qualifying replacement asset. The acquisition cost of the replacement asset is reduced by the amount of the gain being rolled over.
Therefore, tax is postponed until the replacement asset is sold and no new qualifying replacement asset is purchased. It is possible to roll over gains indefinitely, provided sufficient qualifying replacement assets are bought within the time limits.
Qualifying assets
Only certain types of the following assets attract Rollover Relief, including for example:
- land and buildings;
- goodwill;
- fixed plant and machinery;
- ships and hovercraft;
- aircraft, and
- Lloyd’s syndicate capacity.
Timing and Scale of Purchase
The replacement asset must be purchased within 12 months before or three years after the sale of the old asset.
Example
Sale proceeds of qualifying assets (eg aircraft) £200,000
Less acquisition cost £(100,000)
Less indexation allowance £(20,000)
Chargeable gain before rollover relief £80,000
Price of qualifying replacement asset (eg spacecraft) £250,000
Less gain to be rolled over £(80,000)
New tax base cost of spacecraft £170,000
Use of proceeds of sale
Rollover Relief can be restricted when not all of the sale proceeds of the original asset are used to acquire the new asset.
The amount by which the sale proceeds of the original asset exceed the cost of the replacement asset is deducted from the chargeable gain before Rollover Relief and only the remaining amount of the gain can be rolled over.
Essentially the gain to be rolled over is reduced by £1 for every £1 of the sale proceeds not reinvested.
