The Chartered Tax Adviser Examination

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1 The Chartered Tax Adviser Examination July 2017 Taxation of Major Corporates An Advisory paper developed as part of the Joint Programme with the ICAEW leading to the ACA and CTA TIME ALLOWED 3 ¼ HOURS plus 15 minutes reading time You should answer all SIX questions. Start each answer in a new answer booklet. At the end of the examination put all answer booklets used in the envelope provided. Ensure your candidate number appears on all answer booklets used and on the front of the envelope. All workings should be shown and made to the nearest month and pound unless the question specifies otherwise. Marks are specifically allocated for presentation. Candidates who answer the law elements in this paper in accordance with Scots law or Northern Ireland law should tick the appropriate box on the front of each answer booklet. Unless otherwise indicated by the provision of additional table information, you may assume that 2016/17 rates and allowances continue to apply for 2017/18 and future years. Candidates referring to actual or pending rates and allowances for 2017/18 and future years will not be penalised.

2 1. You work for a firm of Chartered Accountants. One of your clients is Shark Ltd, which is the only UK subsidiary of Manatee SA, the parent company of a multinational group headquartered in France. Shark Ltd is a manufacturing company making the majority of its purchases from, and sales to, related parties in France and Germany. Shark Ltd prepares its accounts under IFRS and its functional and presentational currency is the Euro. You have been provided with the following financial information for Shark Ltd for the year ended 31 March All figures are stated in Euros except for those highlighted in Note 4. Income statement Note Revenue 316,700,000 Cost of sales 1) (272,700,000) Gross profit 44,000,000 Administrative expenses 2) (24,900,000) Distribution costs (7,210,000) Profit before taxation 11,890,000 Notes 1) A depreciation charge of 28.5 million is included within cost of sales. 2) Administrative expenses include: Impairment of trade receivables (see Note 3) 1,050,000 Profit on disposal of property (see Note 4) (4,800,000) Release of bonus accrual (see Note 5) (700,000) Repair costs for second-hand machinery (see Note 7) 150,000 3) The impairment of trade receivables comprises the following: 1% of all third party receivables 88,000 Impairment of amounts owed by Tuna GmbH, a German connected party 962,000 1,050,000 The impairment of third party receivables was based on historic objective evidence. 4) A fire that broke out on 1 May 2016 destroyed one of Shark Ltd s buildings and the machinery inside. On 1 November 2016, after lengthy discussions, Shark Ltd s insurance providers, based in France, agreed to pay out the following: Insurance proceeds Basis of pay out Building 13,565,000 Market value at 1 May 2016 Machinery 530,000 Net book value at 1 May ,095,000 Payment was made on 31 January The building, which was used solely for the purposes of the company s trade, was acquired on 1 May 2013 for 8,320,000 (Sterling), and a further 1,200,000 (Sterling) was incurred on 1 November 2013 on an extension. Management have committed to spending 11 million (Sterling) by the end of 2018 on a replacement building. Continued Page 2 of 9

3 1. Continuation There were no other items of property, plant and equipment disposed of during the year. 5) Included within the administrative expenses for the year ended 31 March 2016 was a staff bonus accrual of 3,200,000. 2,500,000 was paid out in January 2017 and the remaining 700,000 was released to the income statement in March No deduction was taken for the 3,200,000 expense in the March 2016 tax return. 6) During the year it was discovered that an employee of Shark Ltd had been stealing stock from one of the warehouses. The overall loss to Shark Ltd has been calculated at 30,000 and is included within cost of sales. 7) The main pool had a tax written down value of 13,134,000 at 1 April The following assets were purchased during the year: New machinery (see (a) below) 6,450,000 Second-hand machinery (see (b) below) 60,000 Compressed gas system to serve new machinery 379,000 Air conditioning systems (see (c) below) 840,000 Electric shutters for factory windows 85,000 Fire alarm and sprinkler systems 96,000 7,910,000 (a) (b) (c) Included within new machinery is a welding machine that was acquired from Manatee SA for 120,000 on 1 February 2017 when the market value was 105,000. Manatee SA had acquired the welding machine in 2015 for 110,000. The other new machinery was purchased from unconnected companies. The second-hand machinery was purchased as a temporary measure after the fire in May 2016, but was in very poor condition when acquired. Shark Ltd incurred 150,000 on repairs to bring the machinery into working condition and this expense is included within cost of sales. The air conditioning systems were installed throughout Shark Ltd s buildings during February Under the terms of the contract, Shark Ltd was due to pay 40% of the purchase price upon installation, another 30% on 30 April 2017 and the remaining 30% on 31 July 2017; however, Shark Ltd paid the full amount on 30 April None of the assets acquired during the year is listed on the Energy Technology Product List. 8) Sterling to Euro exchange rates: Spot rate for 1 May = 1.18 Spot rate for 1 November = 1.20 Spot rate for 1 May = 1.26 Spot rate for 1 November = 1.23 Spot rate for 31 January = 1.21 Average rate for the year ended 31 March = ) All transactions with related parties have been carried out at arm s length. Calculate the Corporation Tax liability for Shark Ltd for the year ended 31 March 2017, with supporting workings and explanations as appropriate. (20) Page 3 of 9

4 2. You are the newly appointed Tax Manager at Midnight plc, a UK headquartered manufacturing group. The Midnight group has a December year end, operates throughout Europe and employs over 250 people. You have just finished a meeting with Stan Broker, the Finance Director of Midnight plc, regarding Twilight Ltd, a wholly owned UK subsidiary of Midnight plc. Twilight Ltd manufactures electrical components from raw materials bought from third parties. The components are used to create finished products, which are then sold to third parties. On 1 January 2015, the Belgian branch of Twilight Ltd was incorporated into Dusk BVBA, a wholly owned subsidiary. Dusk BVBA is tax resident in Belgium and carries on the same trade as Twilight Ltd. All of Dusk BVBA s sales are to third parties in Belgium. From 1 January 2015, Twilight Ltd began selling some of its manufactured electrical components to Dusk BVBA for Dusk BVBA to use in its own manufacturing processes. On 1 June 2017, HM Revenue & Customs opened an enquiry into Twilight Ltd s Company Tax return for the year ended 31 December 2015 and have asked to see the intercompany sales agreement between Twilight Ltd and Dusk BVBA. Stan has reviewed the agreement and discovered that Twilight Ltd has been selling electrical components to Dusk BVBA without any mark-up on cost. HM Revenue & Customs have also asserted that Twilight Ltd is a dependent agent of Dusk BVBA. Stan is not sure what this means, nor what the potential Corporation Tax implications are, but he is aware that Twilight Ltd signed some contracts on Dusk BVBA s behalf in January 2015 before Dusk BVBA had set up its own authorisations. Draft a memo to Stan Broker explaining the Corporation Tax implications of the matters raised by HM Revenue & Customs and the steps the group should take to address the issues. You should assume that the double tax treaty between the UK and Belgium is identical to the OECD Model Treaty. (15) Page 4 of 9

5 3. You are a tax manager in a firm of Chartered Accountants and your client is Goblin plc, the quoted parent company and main UK trading company of a multinational group that manufactures domestic and industrial kitchen appliances. The Tax Director of Goblin plc, Dominic White, has asked you to summarise the impact for Goblin plc following the changes to the Patent Box legislation made in Finance Act You have established the following: 1) Goblin plc has a 30 June year end and elected into the Patent Box regime with effect from 1 April ) Goblin plc holds no qualifying intellectual property (IP) other than patents relating to components incorporated into the products that it manufactures and sells. Every patent held has been developed within the Goblin group; none has been acquired. 3) A review undertaken in 2013 concluded that all of Goblin plc s products contained at least one patented item and so all sales would constitute relevant IP income. However, Dominic raised concerns at the time that the company didn t appear to have visibility over the exact number of patented components within each particular product. 4) Goblin plc has never used the streaming method to calculate relevant IP profits. 5) Goblin plc s qualifying research and development (R&D) spend has been consistent over the last few years and is forecast to remain at a similar level. The amount of R&D subcontracted to non-uk group companies is forecast to increase to approximately 35% of qualifying R&D spend. No R&D is subcontracted to third parties. 6) During the year ended 30 June 2017, a number of patents were granted to Goblin plc. Some of these patents were incorporated into products that already contained patents granted to Goblin plc in a previous year. Draft a letter to Dominic White setting out how the changes to the Patent Box legislation made in Finance Act 2016 are likely to impact Goblin plc. (15) Page 5 of 9

6 4. You are a senior tax adviser in a firm of Chartered Accountants that provides tax advice to the Pharma X group, a global pharmaceutical group. Pharma X SARL, the parent company of the group, is incorporated, tax resident and listed in Luxembourg. The current group structure is set out below with all subsidiaries being wholly owned with the exception of Medmini Ltd. On 30 June 2017, Pharma X SARL disposed of a 60% shareholding in Medmini Ltd to an unrelated party. The jurisdiction of incorporation and tax residency of group companies being as stated: Pharma X SARL (Luxembourg) 40% PMeddy Ltd (UK) JFPX Ltd (Jersey) Medmini Ltd (UK) USPX Inc (US) GPX GmbH (Germany) JFPX Ltd is the group finance company; all other subsidiaries are trading companies. Pharma X SARL prepares consolidated financial statements under IFRS. The results of all companies, except for Medmini Ltd, are expected to be included in the consolidated financial statements for the year ending 31 December PMeddy Ltd has a number of intra-group loans. The forecast movement for the year ending 31 December 2017 is as follows, with profits and losses accruing evenly over each month of the year: PMeddy Ltd Opening position at 01/01/2017 Estimated closing position at 31/12/2017 Estimated income / (expense) million million million Receivables Due from GPX GmbH Payables Due to Pharma X SARL (100) (100) (9) Due to JFPX Ltd - (100) (9) Loss on interest rate swap - - (1) (50) (190) (18) In a recent meeting, Oliver Harris, the group s UK Financial Controller, advised you that the group is expanding the existing transfer pricing policy to cover intra-group financing transactions and requested advice on what issues would be typically included together with the risks for UK companies. Continued Page 6 of 9

7 4. Continuation Oliver has also asked you to explain the tax consequences of the following matters in advance of him preparing Corporation Tax calculations for PMeddy Ltd and Medmini Ltd in support of half year group financial reporting for the year ending 31 December 2017: 1) On 30 June 2015, Pharma X SARL lent US$200 million to PMeddy Ltd to finance the acquisition of the shares of USPX Inc by PMeddy Ltd. The loan carries a floating interest rate of 12-month US$ LIBOR plus a 7.5% margin. The balance outstanding was US$120 million at 31 December Interest expense for the year to 31 December 2017 is expected to be US$10.8 million with no capital being repaid. PMeddy Ltd has a Sterling functional currency. 2) On 30 June 2016, Pharma X SARL issued US$240 million of corporate bonds as the only source of external finance for the group and no principal is due to be repaid until 30 June The bonds carry an annual fixed rate coupon of 10% per annum. 3) On 30 September 2016, PMeddy Ltd lent funds to GPX GmbH under the terms of a Sterling denominated interest bearing loan facility. GPX GmbH had fully drawn down 50 million under the facility at 31 December 2016, with no repayments scheduled for the current year. Interest is charged at a fixed rate of 2% per annum. The group s auditors have requested that PMeddy Ltd impair 80% of the loan at the end of the current accounting period. 4) On 1 January 2017, PMeddy Ltd entered into an interest rate swap with a third party bank that is due to terminate on 31 December Under the terms of the swap, PMeddy Ltd pays a fixed rate of interest of 10% on a notional principal amount of US$120 million and estimates it will receive US$10.8 million to match forecast interest due on the loan from Pharma X SARL. The swap is accounted for as an interest rate derivative. 5) On 31 March 2017, Pharma X SARL subscribed for US$120 million of ordinary shares in JFPX Ltd. On the same day, PMeddy Ltd issued an interest bearing loan note to JFPX Ltd for 100 million with a fixed coupon of 12% per annum. The loan note is repayable on demand and the proceeds were used to pay a dividend to Pharma X SARL on 31 May ) On 31 December 2015, Medmini Ltd, a profitable trading company, was assigned a 50 million loan receivable from PMeddy Ltd. The loan is due from USPX Inc and had a fair market value at 30 June 2017 of 55 million. Interest is charged at a fixed rate of 4% per annum. 7) On 30 September 2016, Medmini Ltd was lent 40 million by JFPX Ltd to fund trading operations. As part of the deal to secure investment in Medmini Ltd, it was agreed that this loan would be waived on 30 September Interest is charged at a fixed rate of 5% per annum. 8) You have been asked to assume an exchange rate of 1.00 = US$1.20. Prepare notes for a follow up meeting with Oliver Harris to brief him on the UK Corporation Tax consequences of the above matters for the year ending 31 December (20) Page 7 of 9

8 5. You are the newly appointed Tax Manager at Luxury Retail plc, a UK incorporated and tax resident holding company of a group that manufactures and distributes luxury clothing for men and women. The group has operations in the UK, the US, France, Germany and Australia, trading through a single subsidiary incorporated and tax resident in each jurisdiction. The UK trading operations are conducted through Exceptional Clothing Ltd. Exceptional Clothing Ltd has been trading for a number of years and operates two entirely separate businesses. One business consists of the manufacture and distribution of luxury clothing for women and the second consists of the manufacture and distribution of business attire for men (the MBA business). You have been advised by Phillipa Cowley, the Group Commercial Director, that the UK arm of a global retailer of men s clothing has made an initial offer of 55 million for the MBA business. The prospective purchaser has stated that they would like to acquire the assets and liabilities of the MBA business but are prepared to be flexible around the transaction structure. Phillipa is aware from a recent transaction that it could be tax efficient to transfer the MBA business into a newly incorporated UK subsidiary of Luxury Retail plc, NewCo Ltd, and instead dispose of the shares of NewCo Ltd. The transaction is expected to complete on 30 September 2017 and Phillipa has requested your advice on the tax and certain legal consequences of a direct sale of the business, together with the alternative transaction she has mentioned, to understand which would be most tax efficient. You have been provided with the following information: 1) The balance sheet of the MBA business as at 30 June 2017 is set out below, together with the estimated fair market value of certain assets at that date. Book Value Fair Market Value Fixed assets Freehold factory 23,375,000 40,000,000 Plant and machinery 7,000,000 4,000,000 Intangible assets (patents) 2,000,000 3,000,000 Intangible assets (goodwill) 3,000,000 Current assets Cash 2,500,000 Trade debtors 500,000 Current liabilities Trade creditors (4,000,000) Loan from Luxury Retail plc (10,000,000) Net assets / (liabilities) 24,375,000 2) Exceptional Clothing Ltd is in a VAT group with Luxury Retail plc and no election has been made to opt to tax the factory used for the MBA business as permitted by Sch.10, Value Added Tax Act ) All patents were registered on or after 1 January ) The goodwill on the balance sheet relates to the historic acquisition of the MBA business from a third party on 31 December ) Assets in the main capital allowances pool are estimated to have a tax written down value of 2 million at 30 June 2016 and include all plant and machinery. Continued Page 8 of 9

9 5. Continuation 6) The freehold factory was acquired for 25 million from a third party on 31 March ) It is proposed that 30 employees will transfer across with the MBA business. 8) Luxury Retail plc has 100 million of external borrowings from overseas lenders. Draft a memo to Phillipa Cowley advising on: 1) The tax implications of the two alternatives for the proposed sale of the MBA business. You are NOT required to estimate the tax payable. (18) 2) The purpose of warranties and indemnities in a Sale and Purchase Agreement. (2) Total (20) 6. You are a tax manager at Golden Accountants LLP and recently met with Howard Sparks, the Group Finance Director of Consumer Friendly Corp, the US incorporated parent company of a global retail group specialising in the sale of food and beverages. The group has a number of well-established overseas trading subsidiaries but has not previously had any presence in the UK. Howard advised you that on 31 March 2017, Consumer Friendly Corp acquired 100% of the shares of Sparkling Fizz Ltd, a UK tax resident and incorporated company with a successful business comprising the manufacture and sale of soft drinks. Sparkling Fizz Ltd last filed a Company Tax return for the year ended 31 December This was filed on time and the Corporation Tax for that period was paid on time. Due to an unforeseen delay by the accountant in finalising the statutory accounts for the year ended 31 December 2015, these accounts were only submitted to Companies House on 30 April Accounting period ended Unpaid Corporation Tax liability 31 December ,000,000 (nothing paid on account) 31 December ,000,000 (estimated) 31 December ,000,000 (estimated) Howard has asked you for advice concerning the Corporation Tax compliance obligations of Sparkling Fizz Ltd. Draft an to Howard Sparks advising on the Corporation Tax administrational issues arising from the above information. (10) Page 9 of 9