lecture 8 - incorporation

Question 1

what are the 6 benefits of incorporation?

Answer 1

Protection from creditors

More credible business profile

Easier to expand the business and to sell shares in it (don’t need partnership agreements drawn up every time you want to add someone into the business).

Lower rate of corporation tax than personal tax
Provides opportunities for income smoothing
Profit can be extracted via dividends (no NIC) rather than salary
corp tax is better, even at the higher profit rate of 25% that’s better than the higher or additional rates of income tax. also, time value of money, if profits stay in business they will be taxed at lower rate and there will be more capital left in there overall.

Company can pay pension contributions direct to pension provider to save NIC (EEs and ERs) — helpful for the owner of the inc in terms of income tax, and for the owner and the company in terms of NIC.

consumption smoothing
if you are inc, can keep profits in business and draw them at amounts that mean you only pay at lower rates (rather than uninc, where if you make the profits you pay the tax in that year).
i.e. if you’re making more than you need to fund your living expenses, inc the business will be beneficial for income smoothing but if you will need to draw it all you’ll just have to pay income tax anyway.

Question 2

what are the negatives of incorporation?

Answer 2

Higher compliance costs
(Corporation tax return
Annual return to Companies House)

Become a director – HMRC scrutiny due to higher rate of tax avoidance.

Company’s money is not one’s own to do with as one pleases

Question 3

what does deciding to incorporate your business lead to?

Answer 3

the owner of the uninc has an asset (the business), which includes all assets in the business too.

assume NBV of business is 50k but fair market value (FMV) is 200,000. this is a capital gain, because he’s selling something for 200k that only cost him 50k to make/put into place.

i.e. you will be charged capital gains tax for incorporating.

Question 4

what is capital gains tax?

Answer 4

Applied on disposals of assets for more than the cost of acquisition

Question 5

how is an individual charged capital gains tax?

Answer 5

charged for tax years like income tax

payable 31 Jan following the tax year

Annual exemption £6,000 (only excess taxable) (in addition to personal allowance for income tax)

Tax at a flat rate of 10% for basic rate income taxpayers or 20% for higher and additional rate income taxpayers. —> Except for realised gains from the sale of residential property that are subject to taxation.

Question 6

how are companies charged capital gains tax?

Answer 6

not liable to CGT but pay corporation tax on net gains instead. Calculation of gain very similar, Indexation may apply.

So capital gains in companies effectively taxed twice: once in company and once on shareholder’s disposal of shares

Companies not entitled to annual exemption

Question 7

what reliefs are available for capital gains tax? which are available to companies?

Answer 7

incorporation relief - available to companies

business asset disposal relief - not available to companies

business asset rollover relief - for companies but not intangibles

holdover relief - for companies selling things at lower price to help customer.

gift relief - not available to companies

Question 8

what is incorporation relief?

Answer 8

Available where a business and all its assets (other than cash) are transferred to a company in exchange just for shares.

Gain on sale of business assets is rolled over into the value of the shares received in exchange.

Effectively a disposal of assets to a company in exchange for shares

have to opt out of incorporation relief. assumption is that you will take advantage of it by default.

Question 9

what might you consider when distributing issues shares for your newly incorporated company?

Answer 9

may wish to distribute some of the issued shares amongst your spouse and children

This would allow the family to extract dividend income (which is free from NI) from the company

they may however have to pay fair value for the shares in order to avoid settlement legislation

This measure will however avoid capital gains tax on you in the future if you plans to give your family a share in the business

lots of sheltering from this. every family member has: personal allowance, div allowance and 6k capital gains allowance.

Question 10

what is the cost base when calculating a capital gain on a share?

Answer 10

cost base is just what the shares are genuinely valued at. deems shares to have cost equal to cost of the asset being transferred. (i.e. if business is worth £300,000, the total amount of shares are worth £300,000. split into x shares, each one worth 300,000/x.

incorporation relief means the cost base in later years is lower, so the overall capital gain is the same, its just triggered once the shares are sold to a third party.

Question 11

what is the history of corporation tax?

Answer 11

Tax on profits of Corporations

Introduced in 1965 (used to pay income tax)

Based on Income Tax rules so many similarities

Recent years diverged in key areas however

Increasingly moving closer to accounting figures

companies are separate legal entities. operations mged by directors, owned by shareholders. profits can be thought of as passing through two layers: they are earned by company itself, then passed onto shareholders, who ultimately have right to profits earned either as capital gains (through share price increases) or in dividends. so, should we tax companies on their profits? should we tax shareholders on their dividends and capital gains as well? first is almost always yes, second one bit less clear cut.

Question 12

how are UK companies liable to corporation tax?

Answer 12

UK resident companies liable to CT on worldwide income

In principle….but, in practice there has been a move toward a more ‘territorial’ system of corporate taxation

in reality, uk corps pretty much only pay corp tax on profits generated in UK. if have subs in other countries, divs recieved are exempt from uk tax. branches overseas also, unless elected otherwise, profits exempt from uk tax. few situations where taxed on profits made outside the uk.

Question 13

are dividends from UK companies liable to corporation tax?

Answer 13

Dividends received from UK companies NOT liable to CT – exclude from total taxable profits. divs paid out of after tax profits, so would be taxing twice.

but are potentially relevant wrt the firm’s effective corporate tax rate, as will see.

Question 14

how does corporation tax differ from income tax in terms of charitable donations?

Answer 14

paid gross

Non-trading donations treated as a charge against total income.

no such thing as gift aid for corps, deduct from total taxable profits.

Question 15

how does corp tax differ from income tax in terms of capital gains?

Answer 15

chargeable gains and allowable losses are subject to corp tax at current rate.

no AEA, the 6k allowance, and compensated for changes due to inflation using indexation allowance rather than reduced rate of tax.

chargeable gain/allowable loss =
gross proceeds on disposal or market value
less incidental cost of disposal
= net proceeds
less allowable costs
= unindexed gain/loss
less indexation allowance
= indexed gain/unindexed loss.

indexation allowance compensates for inflation so companies only pay tax on real gains they make, not those made due to inflation. applied to all items of allowable costs

Question 16

what is a trade loan relationship and a non-trade loan relationship?

Answer 16

any relationship involving borrowing or lending = loan relationship.

trade loan relationship - e.g. firms with suppliers, where they don’t pay, may get charged x% interest until paid off. loan relationship arose from activities firm is in the business of (therefore = trade). same as charging your suppliers interest, goes both ways. bank overdrafts, loans to buy premises/plant and machinery, debentures. companies don’t usually receive income under trading loan relationship unless they’re in the business of making loans.

non-trade loan relationships - e.g. business has excess cash and invests it in bonds rather than in bank account, it generates interest. this is a non-trade loan relationship, not an activity that he’s trading in but it is a loan relationship.

all loan relationships — profits and losses treated as income (i.e. revenue as opposed to capital).

Question 17

how are capital allowances calculated under corporation tax?

Answer 17

everything known so far for module fine and applies.

From 1 April 2023 (until March 2026?) — full expensing relief.

Plant & Machinery x 100% w/off — like AIA without cap. FOR MAIN POOL

From 1 April 2021 until 1 April 2027 (?)

50% FYA for Special Rate assets, other 50% goes into special rate pool.

In addition to / not instead of AIA. e.g. for special rate, can use AIA rather than only getting 50% in first year.

Question 18

what is a ‘close’ company?

Answer 18

shares held by only small number of people, often related as in family companies. concerns that these could be used for tax avoidance, so special set of rules applies to them.

for tax purposes, close = controlled by 5 or less shareholders or any number of shareholding directors, referred to as participators.

Question 19

what are the consequences of being a close company for corporation tax purposes?

Answer 19

additional tax charge of 33.75% that must be paid when close company makes loan to one of its participators. makes sure some tax is paid when profits extracted from company other than as dividend. if loan repaid before due date for payment of corp tax, penalty tax not imposed. if repaid in full or part, or company writes loan off, may reclaim penalty tax from HMRC.

benefits given to participators and their associates that are not taxable as earnings are treated as distrbituions, so company cannot deduct cost of benefit and its value is treated as a dividend in the hand of the pptor.

Question 20

what figure are companies taxed on for corporation tax?

Answer 20

companies taxed on full amount of profits or gains or income arising in accounting period, after deductions authorised by corp tax acts.

Question 21

how is the accounting period to be assessed determined?

Answer 21

normally the accounting year

accounting period of a company starts (for tax purposes) whenever:
company comes within charge to corp tax, usually on commencing to trade as a company, or immediately after the end of a previous accounting period, if the company is still within the charge to corp tax.

accounting period ends on earliest of:
12 months after start of period
accounting date of company or, if company doesn’t make up accounts, end of that period
company starting or ceasing to trade
commencement of a winding up
date on which company ceases to be a UK resident
date on which it ceases to be liable to corp tax.

accounting period = accounting period for tax purposes
cannot be longer than 12 months. if less than 12 months, becomes own chargeable period.

period of account = reporting period for financial accounting purposes.
If more than 12 months, split into 12 months versus additional months / excess. Need to apportion different components in different ways.

Question 22

how are the respective income chargeable components calculated for corporation tax?

Answer 22

income and expenses normally allocated to accounting period in which they accrue however fact that companies can’t have accounting period over 12 months may complicate things. if over 12 months, split income and expenses between two periods in following ways:

trading profits and misc income before CA:
apportioned on time basis. doesn’t necessarily reflect exactly when any particular income is earned.

capital allowances, inc balancing allowances/charges:
compute figs based on actual expenditure or disposals. WDA percentages need to be reduced for short accounting periods. although short period of account results in adjustment to capital allowances available, never any reductions in CAs for private use of assets. instead any private use may be charged on the user as a BIK under employment income rules.

bank interest and other non-trading loan relationships: accruals basis

other income usually allocated on actual basis to period it relates

qualifying charitable donations - allocated to period in which they’re paid

chargeable gains - realisations basis.

Question 23

how are taxable total profits calculated for corporation tax?

Answer 23

aggregate all sources of income: eg trading, property, non-trading loan relationship, etc.

include capital gains.

remember that divs received by UK company from other companies are excluded from tax computation.

Question 24

how are charitable donations taxed under corporation tax?

Answer 24

no tax band extensions. qualifying gifts are deductible under charitable donations relief. paid gross by company (so don’t gross up again), and no further tax reclaimable. amount is deductible when calculating taxable profits.

donations to local charities which are small in amount and wholly and exclusively for purposes of trade are allowable deductions from trading profits.

amount added back = amount included in profit and loss account (usually accruals basis).

Question 25

how is the rate of corporation tax to be charged calculated?

Answer 25

rate set for financial years - runs 1st apr to 31st march.

Augmented Profits’ > £250,000 = Standard Rate = 25%

‘Augmented Profits’ < £50,000 = Small Profits Rate = 19%

between these (£50,001 - £250,000) a sliding scale applies, 19% - 25%

Calculate CT @ 25% then reduce by Marginal Relief:

Standard Fraction x (U – A) x (N/A)

U = Marginal Relief Upper Limit (£250,000)

A = Augmented Profits (TTP + UK Dividends)

N = Total Taxable Profits (TTP)

Standard Fraction = 3/200

Question 26

what is the proforma for calculating corporation tax due?

Answer 26

TATP
+
non-trading loan relationship
+
capital gains
-
charitable donations
=
total taxable profits (TTP)

gross CT - total taxable profits x CT rate

Question 27

how does the corporation tax rate change for associated companies?

Answer 27

where company has associated companies, bands are divided between total no of associated companies, inc the one you’re calculating tax for. associated if one controls the other, or if both are owned by same person(s). associated companies do not have to be UK resident. control = holding over 50% of share capital or voting power or being entitled to over 50% of the distributable income/net assets in a winding up. dormant companies now counted.

reduce limits for marginal relief if period less than 12 months long

Question 28

what is the ATR and MTR at each profit level for corporation tax?

Answer 28

profits up to 50k: ATR and MTR = 19%

profits between 50 and 250k: ATR somewhere between 19-25%, MTR = 26.5% if N=A

profits 250k or more: ATR and MTR = 25%

Question 29

what is an imputation? how does it relate to corporation tax?

Answer 29

imputation system used so that shareholders given tax credit for some of corp tax which had been paid by company. primary advantage of this system is over taxation on distributed profits is reduced. because div income still taxed, still some overtaxation of corporate profits. system effectively remains a partial imputation system.

when companies retain profits, increase in share value that results may be chargeable to capital gains tax when shares are sold.

Question 30

how does a self assessment for corporation tax work?

Answer 30

Company performs own tax computation and pays tax due on ‘due date’

Due date = 9 months + one day after year end unless large company

HMRC have up to a year from date return due to be filed (or actually filed) to query calculations, if they don’t the year is completed.

Question 31

how do large companies pay corporation tax?

Answer 31

Large companies (> £1.5m ‘augmented profits’) make quarterly payments on account during tax year

Due dates

1st payment = 14th day of 7th month of period

3 further payments at quarterly intervals

e.g. for company with 12 month period ending 31st Dec, quarterly payments are 14/07, 14/10, 14/01 and 14/04.

(final settlement payment due 3 months and 14th days after period ends so has time to work out correct balance for year)

Question 32

how do larger companies pay corporation tax?

Answer 32

Large(r) companies (> £20m ‘profits’) make quarterly payments on account even earlier (3rd/6th/9th/12th mo.)

Question 33

how can you extract profits from your company once incorporated?

Answer 33

rent - as in winston charging rent. may have a home office that you rent to your corp. rent is deductible for corp tax, and no NIC. means he can avoid corp tax and NIC this way.

interest - business needs operating capital so shareholder sets up loan to company and charges interest on the loan. interest deductible for corp tax, no NIC and PSA!

pension contributions direct by company - no income or NIC, deduction from profits at corporation tax computation. good if you don’t need money to fund lifestyle.

salary

dividends

Question 34

for each income tax level, is it better to take money out of your incorporated business as salary or dividends?

Answer 34

basic — divs better

higher — salaries marginally more tax efficient, but pretty even

additional — salaries slightly more efficient, again fairly even.

THIS ASSUMES CORP TAX AT 25%

imagine, if small profits and taxed at 19%, dividends will be better for higher and additional.

Question 35

what should be considered when taking money out of your incorporated business as dividends?

Answer 35

Dividends can only be paid out of distributable reserves. only available out of retained profit, may not be enough to fund your lifestyle.

Dividends have to be paid to all shareholders indiscriminately whilst salary can be tailored to ‘contribution’. if your family are all class A you all have to have at same rate (easily fixable by setting up differently).

Dividend income is not pensionable (though Winston’s pension contributions would be paid by company)

Salary provides a regular income