The Chartered Tax Adviser Examination

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1 The Chartered Tax Adviser Examination November 2015 Advanced Corporation Tax Advisory Paper TIME ALLOWED 3 ¼ HOURS The first 15 minutes is designated as reading time. During this time you may read your question paper and legislation and annotate your question paper. You are not permitted to write in the answer folder. The Presiding Officer will inform you when you can start writing. Calculators may not be used during this time. You should answer all SIX questions. Start each answer on a new sheet of paper and write on one side only. Do not write in the margins. 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 any 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 folder. Unless otherwise indicated by the provision of additional table information, you may assume that 2014/15 rates and allowances continue to apply for 2015/16 and future years. Candidates referring to actual or pending rates and allowances for 2015/16 and future years will not be penalised.

2 1. You are the new Tax Adviser to Wort Ltd, a brewer. The company was set up in 2010, owns the freehold of its factory and is now highly profitable. Wort Ltd has three shareholders. Terry Brooks and Tina Brooks are directors of Wort Ltd and each owns 45% of Wort Ltd s shares. Tony Richards owns the remaining 10% and is not a director or employee. He is retired and no longer working. Wort Ltd makes up its accounts to 30 September each year under UK GAAP. You have had a meeting with Gavin Holmes, the Finance Director, to discuss their plans for the year to 30 September You were given the following information: 1) Wort Ltd plans to incur the following expenditure: (a) Repairs to its heating system at a cost of 40,000. When installed in 2011, the heating system cost 70,000. (b) (c) (d) Purchase of second hand brewing vats costing 150,000. The expected remaining useful life is 22 years. The vats were purchased brand new in 2010 by the vendor at which point their useful life was about 27 years. Alterations to the site at a cost of 50,000, which are required to accommodate the brewing vats. Purchase of 200 new thermometers at a cost of 10,000 in total. They have an expected useful life of seven years. 2) Wort Ltd will sell some beer barrels (in the main pool for capital allowance purposes) to Tony Richards for 5,000. Their actual market value is 9,000. Tony Richards will then resell the barrels. 3) The following equipment is to be purchased on finance leases with no option to purchase at the end of the lease: (a) Bottling line with a lease term of eight years and annual rental at 20,000. (b) Intruder alarm with a lease term of nine years and annual rental of 4,000. The amounts that should be recognised in the accounts under UK GAAP are 100,000 for the bottling line and 30,000 for the intruder alarm. 4) The Annual Investment Allowance will be fully utilised on the purchase of other general equipment. 5) Wort Ltd is proposing to buy a brewing company, Tuns Ltd, currently a wholly owned subsidiary of Cask Ltd, a company unconnected to Wort Ltd, which is selling its brewing interests. Gavin Holmes told you, We want to buy the share capital of Tuns Ltd, not the trade and assets. Tuns Ltd is still trading but is almost defunct and is very cheap. Our initial due diligence suggests that Tuns Ltd has a huge brought forward balance on its main capital allowances pool although the company s capital equipment is depreciated to almost nothing in its accounts. The company has not replaced anything for years and the equipment is obsolete. Nonetheless those allowances look tempting. The company has also made some trading losses in previous years which have been carried forward unused. You are required to write a report to the Finance Director of Wort Ltd advising him on the Corporation Tax consequences of the above matters. Calculations are NOT required. (20) Page 2 of 9

3 2. You are the Group Tax Manager at Sail Ltd, a parent company with one wholly owned subsidiary, Jib Ltd, and a 40% shareholding in Mast Ltd (with the remaining 60% being owned by an unconnected shareholder). Sail Ltd sells nautical equipment. Jib Ltd and Mast Ltd sell clothing. All three companies are UK tax resident and make up their accounts to 31 March. A review of the intercompany account of Jib Ltd at 31 March 2015 reveals the following balances due to Sail Ltd: 1) Loan from Sail Ltd 300,000 2) Unpaid invoices for bookkeeping services provided by Sail Ltd 20,000 It is now proposed that these amounts, which remain outstanding, are formally waived by Sail Ltd since Jib Ltd is unable to repay them. Mast Ltd also had a loan from Sail Ltd with a balance outstanding at 31 March 2015 of 30,000. Mast Ltd was heavily loss-making so Sail Ltd made an impairment provision against the whole 30,000 debt in its accounts for the year to 31 March Mast Ltd was put into liquidation on 3 May The liquidator has now agreed with Sail Ltd that the whole 30,000 will be written off. Sail Ltd is thinking of purchasing the entire share capital of Mizzen Ltd, which is currently owned by Warthog Ltd. Warthog Ltd is not connected with Sail Ltd. Mizzen Ltd has been trading very poorly although there are no tax losses. However, it currently has an outstanding loan due to Warthog Ltd of 100,000, which it is unlikely to be able to repay. Sail Ltd could acquire both the loan and all of Mizzen Ltd s share capital from Warthog Ltd for a nominal 1 and try to revive the company. Your Group Finance Director has told you that the 100,000 loan will then be due to Sail Ltd. You are required to write a memorandum to the Group Finance Director explaining the Corporation Tax implications of the above matters. (15) 3. You are a Tax Manager at a firm of accountants, Smith Accountants LLP, and have been assigned to a new client, White Ltd. You have recently met Mr Blue, the newly appointed Finance Director of White Ltd, who has limited tax knowledge. He has advised you of the following. White Ltd has 10 shareholders, none of which are employees. It has only two sources of income: dividends receivable from wholly owned UK subsidiaries and a small amount of interest receivable from monies held on deposit in bank accounts. White Ltd acquired all of the shares of Cyan Ltd on 1 April 2014, after incurring legal and accountancy fees of 250,000. The acquisition of Cyan Ltd was partly financed by new bank loans. Interest payable thereon for the accounting period ended 31 March 2015 was 1,500,000. The bank arrangement fees of 150,000 are amortised for accounting purposes over the 10-year term of the debt in accordance with UK GAAP. During the year ended 31 March 2015, White Ltd considered acquiring another UK company, Purple Ltd. Legal and accountancy fees of 100,000 were incurred on initial investigations and due diligence but ultimately the acquisition was not made. The shareholders of White Ltd have recently received an offer from a third party UK resident company, Rouge Ltd, to acquire the entire share capital of White Ltd. If acquired by Rouge Ltd, Rouge Ltd would change White Ltd s investment portfolio to include investment properties. You are required to write a letter to Mr Blue explaining the Corporation Tax consequences of the information provided by Mr Blue (15) Page 3 of 9

4 4. You are a Tax Manager at Worldtax LLP and have attended a meeting with Kerry Jones, who is the Group Finance Director of your client, Spark Ltd. Spark Ltd is tax resident in the UK and is a specialist supplier of locks and ironmongery. It has two overseas permanent establishments (PE1 and PE2) located in Ruritania and Pangaea, respectively. Spark Ltd also has a 5% interest in the share capital of Boltex Ltd, which is tax resident in Utopia. The remaining shares of Boltex Ltd are owned locally by Utopian residents. Ruritania, Pangaea and Utopia do not have a Double Taxation Agreement with the UK. In the year ended 31 March 2015, summary turnover and costs were as follows: Spark Ltd UK Income ( 000) PE1 Ruritania ( 000) PE2 Pangaea ( 000) Turnover 25,000 2, Direct costs (5,000) (700) (800) Indirect costs (600) (200) (50) Spark Ltd employed 100 staff worldwide during the year and has no other income or expenses other than those detailed above. None of the costs included above require adjustment for the purposes of calculating the company s tax liability. Local Corporation Tax of 30% was applied by the Ruritanian tax authorities to the profit of PE1. A withholding tax of 20% was applied by the Pangaean tax authorities to the turnover of PE2. Turnover is stated before the withholding tax is applied. For the year ended 31 March 2015, Boltex Ltd paid one dividend totalling 1 million (gross) to all shareholders. A 10% withholding tax was applied to this by the Utopian tax authorities. Spark Ltd is considering setting up two new overseas permanent establishments. Both are expected to be profitable from the start. One will be located in a country which does not levy Corporation Tax. The other will be located in a country with a rate of Corporation Tax similar to the UK. You are required to write a letter to Kerry Jones, explaining the UK Corporation Tax implications of the above information, including a calculation of the UK Corporation Tax liability of Spark Ltd for the year ended 31 March (15) Page 4 of 9

5 5. You are a Tax Manager at a firm of accountants, River Accountants LLP. You have been contacted by a partner in your firm s corporate finance department regarding your firm s client, the Spey group, which is proposing a demerger. The Spey group of companies consists of three companies: the holding company, Spey Ltd; and two wholly owned trading subsidiaries, Don Ltd and Burnawn Ltd. Spey Ltd is jointly owned by two shareholder/directors, Mr Loudoun and Mr Clyde. Mr Loudoun and Mr Clyde have fallen out irrevocably and have therefore decided to break the group up via a capital reduction demerger. This will result in Mr Loudoun owning Don Ltd and Mr Clyde owning Burnawn Ltd, each held through intermediate holding companies. Proposed transactions Step 1: The share capital of Spey Ltd will be re-designated into A and B shares with separate rights attaching to Mr Loudoun and Mr Clyde, respectively. Step 2: A new holding company, Tay Ltd, will be incorporated. Tay Ltd will also have both A and B shares only. Step 3: Mr Loudoun will exchange his A shares in Spey Ltd for A shares in Tay Ltd. Mr Clyde will exchange his B shares in Spey Ltd for B shares in Tay Ltd. From Tay Ltd s perspective, for accounting purposes, its investment in Spey Ltd is booked at market value. Any difference between the market value and the nominal value of the shares issued in Tay Ltd will be taken to a merger reserve. Step 4: Spey Ltd will then sell its shareholding in Burnawn Ltd to Tay Ltd at market value, leaving the consideration on an intra-group loan account. Burnawn Ltd will declare a dividend to Tay Ltd to equalise the value of the investments held by Tay Ltd in Spey Ltd and Burnawn Ltd. Step 5: Mr Clyde will incorporate a new holding company, Tweed Ltd. Step 6: Tay Ltd will reduce its capital under the process allowed by the Companies Act 2006, cancelling the B shares. Part of the merger reserve (mentioned at step 4 above) will be used for this process. Step 7: The investment in Burnawn Ltd will then be transferred to Tweed Ltd at book value. Tweed Ltd in turn will issue shares to Mr Clyde. Post transaction, 100% of Tay Ltd (which owns Don Ltd) will be owned by Mr Loudoun and 100% of Tweed Ltd (which owns Burnawn Ltd) will be owned by Mr Clyde. You are required to write a memo to the Corporate Finance Partner explaining the Corporation Tax and Stamp Duty consequences of each of the steps in the proposed demerger. (15) Page 5 of 9

6 6. The Colonsay group consists of three UK incorporated and tax resident companies: the holding company, Colonsay Ltd; and two wholly owned trading subsidiaries, Skye Ltd and Taransay Ltd. The draft accounting results for the group companies for the year ended 31 March 2015 are as follows: Profit and loss accounts for year ended 31 March 2015 Note Colonsay Ltd Skye Ltd Taransay Ltd Turnover 1 2,000,000 25,500,000 72,000,000 Cost of sales 0 (19,500,000) (55,000,000) Gross profit 2,000,000 6,000,000 17,000,000 Administration expenses Profit/(loss) before finance items and tax Finance income Finance expense Profit/(loss) before taxation 2,3 (1,600,000) (7,500,000) (14,500,000) 400,000 (1,500,000) 2,500, ,000 4 (750,000) (200,000) (1,500,000) 2,500,000 Taxation 5 42, ,000 (525,000) Profit/(loss) after taxation (158,000) (1,185,000) 1,975,000 Page 6 of 9 Continued

7 6. Continuation Balance sheets at 31 March 2015 Investment in subsidiaries Tangible assets Total noncurrent assets Current assets Cash and equivalent Note Colonsay Ltd Skye Ltd Taransay Ltd 6 12,000, ,000 3,250,000 12,000, ,000 3,250,000 2,500, , ,000 Debtors 8,9 3,500, ,000 8,500,000 Stocks 350,000 1,100,000 Total current assets Creditors due within one year Net current assets Creditors due after more than one year 6,000, ,000 9,800,000 (1,502,000) (3,250,000) 4,498, ,000 6,550,000 (9,450,000) (3,500,000) Net assets 7,048,000 1,200,000 6,300,000 Capital and reserves Called up share capital Profit and loss account Shareholders funds 3,000,000 25, ,000 4,048,000 1,175,000 6,200,000 7,048,000 1,200,000 6,300,000 Continued Page 7 of 9

8 6. Continuation Notes 1) Colonsay Ltd s turnover is in respect of management charges levied on Skye Ltd and Taransay Ltd equally. 2) Administration expenses in Colonsay Ltd include: Staff retention bonuses 900,000 Penalty VAT 50,000 Compensation for negligent tax advice (100,000) The staff bonuses of 900,000 accrued at 31 March ,000 was paid on 30 June 2015 and 300,000 is payable on 31 December ) Administration expenses in Skye Ltd and Taransay Ltd include: Skye Ltd Entertainment 35,000 Taransay Ltd Entertainment 50,000 Legal and professional property lease renewal 20,000 (75 year lease) IT costs miscellaneous laptop computers 3,500 Trade subscription fees 50,000 4) Interest income receivable by Colonsay Ltd is in respect of monies held on deposit with UK banks. Interest expense in Colonsay Ltd is in respect of UK bank borrowings (15% per annum). 5) The tax expense booked through the profit and loss account of all three companies is an estimate based on a tax rate of 21% on profit/(loss) before tax. 6) Investments are held at original cost by Colonsay Ltd: Skye Ltd acquired in ,000,000 Taransay Ltd acquired from a third party on 1 January ,000,000 Total 12,000,000 7) Fixed Assets Skye Ltd Taransay Ltd Plant Opening net book value 300,000 3,000,000 Additions 0 500,000 Disposals 0 0 Depreciation (50,000) (250,000) Closing net book value 250,000 3,250,000 Fixed asset additions Taransay Ltd 1 May 2014 Computers 100, September 2014 Wash unit 400, ,000 Continued Page 8 of 9

9 6. Continuation 8) An intra-group loan of 3,500,000 was made on 1 January 2015 by Colonsay Ltd to Taransay Ltd. The loan has a five-year term and is interest free. 9) Taransay Ltd has always included a doubtful debt provision based on a fixed percentage of trade debtors over a certain age. Balance at 1 April ,000 Charge to profit and loss account 55,000 Balance at 31 March ,000 10) Capital allowance pool tax written down value brought forward at 1 April 2014: Skye Ltd 300,000 Taransay Ltd 3,750,000 You are required to: 1) Prepare computations of the Corporation Tax payable for the group companies for the period ended 31 March 2015 with supporting explanations as appropriate. (18) 2) Calculate the deferred tax balance sheet provision for Taransay Ltd at 31 March (2) Total (20) Page 9 of 9