Tax Flashcards
What are direct taxes?
imposed directly on the person or enterprise required to pay the tax, i.e. tax on personal income such as salaries, tax on business profits or tax on disposals of chargeable asset
What are indirect taxes?
This tax is imposed on one part of the economy with the intention that the tax burden is passed on to another. The tax is imposed on the final consumer of the goods or services. The more the consumer consumes the greater the tax paid. An example would be sales tax such as VAT in the UK
What is formal incidence?
This is the person who has direct contact with the tax authorities, i.e. who is legally obliged to pay the tax
What is actual incidence?
This is the person who actually ends up bearing the cost of the tax, i.e. who actually bears the burden of the tax
What is a taxable person?
The person accountable for the tax payment, e.g. individual or entity
What is a competent jurisdiction?
A taxable person normally pays tax in the country of origin. Competent jurisdiction is the tax authority that has the legal power to assess and collect the taxes. This is usually the combined responsibility of the central government and local authorities within a country
What is Hypothecation?
This means that certain taxes are devoted entirely to certain types of expenditure, e.g. road tax is used entirely on maintaining roads, London congestion charge is used to pay for transport for the area
What is the tax gap?
This is the gap between the tax theoretically collectable and the amount actually collected. The tax authorities will aim to minimise this gap
What are progressive taxes?
These take an increasing proportion of income as income rises. (E.g. UK Income tax –20%, 40%, 50%)
What are proportional taxes?
These take the same proportion of income as income rises
What are regressive taxes?
These take a decreasing proportion of income as income rises. (E.g. UK National Insurance contributions –11% then 1%
How is tax on trading income calculated?
$
Accounting Profit X
Less: income exempt from tax or
taxed under other rules (X)
Add: disallowable expenses X
Add: accounting depreciation X
Less: tax depreciation (X)
Add: tax profit on disposal of an asset (BC)
X
Less: tax loss on disposal of an asset (BA)
(X)
___
Taxable profit X
What is a balancing allowance (BA)?
A tax loss on disposal
What is a balancing charge (BC)?
A tax profit on disposal
How is a BA / BC calculated?
$ Proceeds X Less: tax written down value (TWDV) (X)
____
Balance charge/allowance
What are the 4 possible ways of relieving a tax loss?
- Carry losses forwards 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
What is terminal loss relief?
If an enterprise ceases to trade, most countries allow the entity to carry back the 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. The assessment will tell you the terminal loss rules of that country
What are capital taxes?
Gains made on the disposal of investments and other non current assets
How are capital taxes calculated?
Proceeds X Less: costs to sell (X) ––– Net proceeds X Less: cost of original asset (X) Less: costs to buy (X) Less: enhancement costs (X) Less: indexation allowance (X) ––– Chargeable gain X
What is rollover relief?
Rollover relief enables an entity to postpone paying tax on a gain if it reinvests the same proceeds in a replacement asset. The gain is effectively postponed until the replacement asset is sold at some time in the future
What is tax consolidation?
Group loss relief - ax consolidation enables a tax group to be recognised, allowing trading losses to be surrendered between different entities. Some countries enable losses to be surrendered only between resident companies, while others allow overseas entities to be included based on profits within that country
What can give rise to the double taxation of dividends?
Appropriations of profit such as dividends cannot be deducted in arriving at an entity’s taxable profits and are therefore taxable in the hands of the entity, i.e. tax relief is not given for the dividend.The dividend is then distributed to the shareholders who may be taxed on the income as part of their personal tax
What are the 4 ways of dealing with the double taxation of dividends?
Classical system - The shareholder is treated as independent from the entity. The dividend is taxed twice, firstly as part of the entity’s taxable earnings and secondly when received by the shareholder as part of shareholder’s personal income
Imputation system - The shareholder receives a tax credit equal to the underlying corporate income tax paid by the entity. In this way, the entity is taxed on the taxable earnings which are used to pay the dividend, while the shareholder receives a full credit and hence pays no tax on the dividend income
Partial imputation system - A tax credit is offered to the shareholder but only for part of the underlying corporate income tax paid by the entity on its taxable earnings used to pay the dividend
Split rate system - These systems distinguish between distributed profits and retained profits and charge a lower rate of corporate income tax on distributed profits to avoid the double taxation of dividends
Why do group entities tend to transfer funds from one entity to another in the form of interest on inter-company loans rather than dividends?
As a general rule interest is tax deductible and dividends are not. Many countries have addressed this issue by limiting the amount of interest that is tax deductible. Interest in excess of this value will be classified as a dividend. The rules which govern the amount of interest that is eligible for tax relief in this situation are knows as thin capitalisation rules
What is a unit tax?
A tax based on the number or weight of items eg excise duties
What are ad valorem taxes?
A tax based on the value of items eg sales tax
What are excise duties and what are they used for?
A type of unit tax used to discourage over consumption of harmful products, to pay for extra costs such as increased healthcare or infrastructure or to tax luxuries such as in the USA - firearms and air tickets
What are property taxes?
Duh
Wealth taxes
Duh
What are the 2 types of consumption taxes?
Single stage and multi stage tax
Describe single stage taxes
Applied to one level of production only, IE at the manufacturing, wholesale or retail level
Describe multi stage sales tax
Either a cascade tax, whereby tax is taken at each stage of production and is a business cost as no refunds are provided by government, or a VAT where VAT is charged each time a component is sold but the government allows businesses to reclaim all the tax they have paid, the final tax burden being passed on to the final consumer
How is corporate residence determined?
An enterprise is deemed to be resident for tax purposes either in the place of incorporation or place of control/central management
What are the 3 methods of double taxation relief?
1 - Exemption –The countries agree on certain types of income which will be exempt or partially exempt in one country or the other.
2 - Tax credit –Tax paid in one country may be allowed as a tax credit in another country. Relief is normally restricted to the lower of the foreign or country of residency tax.
3 - Deduction –Tax relief is gained by deducting the foreign tax from the foreign income so that only the “net” amount will be subject to tax in the country of residency
What are the features of a subsidiary?
- Separate entity for tax purposes. The holding co will only pay tax on any dividends received from the sub
- Loss relief not available for the group because the overseas sub will be paying tax under a different tax regime
- Can’t claim the same tax depreciation as the parent on any assets though may receive an alternative type of tax depreciation in the overseas country. Assets transferred from the parent may also result in CG tax
What are the features of a branch?
- Branch is treated as an extension of the UK activity and all profits from it will be subject to UK taxation
- Loss relief is available for the group
- Assets can be transferred between the branch and holding company at no gain/no loss
- The branch can claim tax depreciation on all asset
Describe withholding tax
Some countries will deduct tax at source on items such as interest, royalties, rent, dividends and capital gains. The net income (gross payment less tax) is then received by the beneficiary in the foreign country
How does underlying tax work?
When an entity pays out a dividend, it is done so out of post tax profits. Therefore, the amount of profit distributed as a dividend will have already suffered tax on profits. If an entity receives a dividend from an overseas subsidiary, the dividend will have been taxed once in the overseas country as part of normal tax on profits, and then again in the country of receipt, as income on dividends. This tax is known as underlying tax.
What is the OECD model tax convention?
This addresses the issue of double residency. This model states that business profits of an enterprise will only be taxable in a state if an enterprise has a permanent establishment in that country. A permanent establishment could include the following;
- A factory
- A workshop
- An office
- A branch
- A place of management
- A mine, an oil or gas well, or a place of extraction of natural resources
- A construction project or building site if it lasts more than 12 month
How does the OECD deal with entities having a residence in several countries?
Where an entity is deemed to have residency in several countries, the OECD model suggests that the entity is resident in the country of its effective management
How does transfer pricing work?
Transfer pricing applies to group situations when either goods are sold inter-company or a loans take place at a favourable price. Therefore, this results in transactions not taking place at “arms length” and profits being effected by the group members. This could be done when an overseas entity moves profits to another country at a lower tax rate
How do the OECD transfer pricing rules prevent tax avoidance?
- Goods and services –An adjustment will be made in the corporate tax computation for the entity gaining the tax advantage to reflect profit that would have been achieved if the transaction had been arms length
- Provision of loan finance –The rules apply to the amount of the loan and interest charged on the loan. Thin capitalisation refers to the situation where the amount of loan finance provided to a connected company exceeds the amount a third party would be willing to provide. This results in the Interest charged on the amount of the loan that exceeds the amount a third party would lend is not allowable for tax purposes and will therefore be disallowed
