F1 - Tax Flashcards
What are 2 reasons that a government might raise a tax?
- To finance public expenditure
2. To moderate behaviour
What are the 5 main aspects of a good tax policy?
- Equity and fairness
- Transparency
- Certainty
- Efficiency of collection
- Minimum tax gap
What is the tax gap?
The difference between the amount theoretically collectable by the government and the amount actually collected
What is hypothecation?
Where tax is raised for specific purposes
What is the incidence of a tax?
The incidence of a tax is on the person who pays the tax, and can be formal (who has direct contact with the tax authority) or actual/effective (who bares the cost of the tax)
What are the 3 methods of tax proportion?
- Progressive tax (higher at higher levels)
- Proportional tax (same at all levels)
- Regressive tax (lower at higher levels)
What is a direct tax?
One which cannot be passed on to another taxable person and is paid directly to the government e.g. PAYE
What is an indirect tax?
A tax which is collected by intermediaries on behalf of the government but borne by the final consumer e.g. VAT
What are unit taxes?
Taxes charged per unit or weight
What are ad valorem taxes?
Taxes based on value
What are excise duties?
A type of unit tax charge to discourage overconsumption, improve infrastructure or to promote growth of home industries
What are the 3 conditions that normally apply to excise duties?
- Easy to define products
- Produced in large volumes by a few large producers
- Inelastic demand with few substitutes
What is VAT?
A multi-stage consumption tax, where VAT is charged at each stage but companies can reclaim input VAT - the entire burden of VAT is passed on to the final consumer
What must a company do as a ‘taxable person’?
- Keep VAT records
- Charge output VAT
- Reclaim input VAT
- Complete a VAT return and pay off the net amount of output - input VAT
What are zero rated supplies?
Supplies with 0% VAT, such as non luxury food and childrens clothes
What are exempt supplies?
Supplies not subject to VAT such as finance and insurance
What is the calculation for taxable amount of employment income?
Salary + bonuses + commission + benefits - business expenses
What are the 5 benefits of using a PAYE system?
- Cash flow and budgeting advantage to the authority (collected each month)
- Tax payment is easier for the individual
- Administration costs are borne by the employer
- High proportion of taxes are received
- Tax authority only have to deal with 1 employer
What are the 4 options for dealing with double tax on dividends?
- Classic system - dividend income is taxed twice
- Imputation system - individual is given full credit for the tax already paid by the company
- Partial imputation system - individual is given some credit for the tax already paid by the company
- Split rate system - company profits used for dividends are taxed at a different rate
What are the 4 main sources of tax rules?
- Domestic legislation (code law)
- Case law (precedents)
- Directives from supranational bodies (e.g. EU)
- International taxation agreements
What 3 things must companies do regarding tax to comply with legislation?
- Keep adequate records
- Keep the records for specified minimum time
- Submit tax payments by certain deadlines
What are the 3 reasons that there are deadlines for filing and paying tax?
- Tax payers know when payment is due therefore it is more likely
- Tax authorities can forecast cash flows
- Tax authorities can impose penalities on late payments
What 4 things do tax authorities have the power to do?
- Review and query tax returns
- Examine supporting documentation
- Impose penalties on late payments
- Enter and search a business
They CANNOT arrest individuals
How do you get from accounting profit to taxable profit?
Accounting Profit
- Exempt income (e.g. grants, rental income)
+ Disallowable expenses (e.g. entertaining, donations)
+ Accounting Depreciation
- Tax Depreciation
= Taxable profit
Why is there a difference between accounting depreciation and tax depreciation?
Accounting depreciation is not calculated consistently as it is a judgement on the treatment used and so could be used to manipulate the tax charge
What happens for tax purposes when an asset is sold for less than its tax base?
A balancing allowance is taken away from taxable profit
What happens for tax purposes when an asset is sold for more than its tax base?
A balancing charge is added to the taxable profit
What happens for tax purposes when an asset is sold for more than its original cost?
A balancing charge of the total of all previous allowances is added, and there may also be a capital gains tax
What is the calculation for a capital gain?
(Disposal proceeds - expenses) - (cost of asset + expenses)
What is indexation?
An allowance for inflation on capital gains
What is rollover relief?
Payment on a capital gain can be delayed if the full proceeds from the sale are reinvested in a replacement asset
How is a companies country of residence decided?
The country of incorporation/where board meetings are held/ head office is
What are the 2 main tax differences between establishing overseas operations as subsidiaries, or as a branch?
- Separate tax entity vs extension of the home entity
2. Parent company is taxed on dividends vs taxed on all profits
What is the OECD model tax treaty?
A treaty that determines which country should tax profits made by a company with presence in multiple countries, stating that if a company has permanent residence then it may be taxed in that country.
E.g. office, workshop, branch, factory
What is DTR?
Double tax relief allows a business to offset the tax paid in one country against the tax bill in the other
What is the tax credit method of DTR?
DTR is given for the lower of overseas tax and resident country tax, by the resident country
Why do countries charge withholding tax?
To deter overseas countries from investing in their country and then sending all of the profits back home
What is withholding tax?
A tax on any payments leaving the country such as dividends, interest and royalties
What is underlying tax?
The tax that has already been paid on profits from which a dividend is paid
What is transfer pricing?
The process of setting the price of goods sold by one group company to another
Why do tax authorities impose transfer pricing third party rules?
To prevent groups of companies from using inter-company pricing arrangements to inflate profits in low tax rate countries
What are the 2 adjustments made to taxable profit if unfair transfer pricing is used?
- Adjustment for non arms length transactions
2. Interest charged on thin capitalisation is added back to taxable profits
What is tax avoidance?
The legitimate use of tax rules to minimise the amount of tax payable
What is tax evasion?
Illegally deceiving the tax authorities
How might governments minimise tax avoidance and evasion? (4)
- More legislation to close loopholes
- Auditing systems
- Creating a tax system that is perceived as fair
- Imposing penalties for evasion
