The Chartered Tax Adviser Examination

Transcription

1 The Chartered Tax Adviser Examination May 206 Advisory Advanced Corporation Tax Suggested Solutions

2 Question Part Corporation Tax Computation Accounting period ended 3 December 205 Note Loss per accounts (24,570,000) Add: 2) Charitable donations 60,000 3) Share based payment charge 5,000,000 4) Rental payments for printing press 70,000 5) Depreciation 0,000,000 Deduct: 6) Profit on disposal (50,000) 5,30,000 (9,440,000) 7) Expense relief for royalty (20,000) Capital allowances (5,080,000) (5,250,000) Taxable total profit/(loss) (4,690,000) Charitable donations (30,000) Notes ) Interest payable should be treated as a trading loan relationship debit because the overdraft is used for the working capital of the business and therefore no adjustment is required. 2) The charitable donations were paid to a registered charity and therefore are qualifying charitable donations. These are deductible from total profits after all available reliefs (except group relief) but only if they are actually paid in the year. 3) The share based payment charge in the accounts is non-deductible and should be added back. 4) The printing press is held under a long funding lease on the basis the asset is held under a finance lease which was entered into after April 2006 and the lease was over 7 years long when it was entered into. The rental element of the lease payments on the printing press is non-deductible and should be added back. Instead, capital allowances are available in respect of the asset (see below). The amounts included within the rental payments which are accounted for as interest in relation to the finance lease, are deductible trading expenses and as such, no adjustment is required in respect of these. 5) Depreciation is non-deductible and should be added back. 6) Profit on disposal of fixed assets should be deducted as this relates to capital. The proceeds relating to the fixed assets sold will be dealt with in the capital allowances calculation (below). 7) Double tax relief is available for the withholding tax on the royalty payment by way of credit relief. On the basis that Melbaide Publishing Ltd is not tax paying in the period to 3 December 206, credit relief is not available. Instead, Melbaide Publishing Ltd can elect out of credit relief, which provides that the income being taxed in the UK in relation to the royalty is reduced by the sum paid in respect of non-uk tax. ( 5%)

3 Capital Allowances Computation Note Main pool Special rate pool Allowances TWDV b/f 9,500, ,000 9,500, ,000 8) Proceeds labelling machine (50,000) 9) Proceeds printing press (35,000) 0) Proceeds car (5,000) ) Proceeds on cessation (4,65,000) (85,000) TWDV 4,800, ,000 2) Balancing allowance (4,800,000) (280,000) 5,080,000 TWDV c/f - - 8) The deduction from the pool in respect of the sale of the labelling machine should be the proceeds received for the sale. 9) Melbaide Publishing Ltd, as lessee, can claim capital allowances on the printing press. As the lease was terminated in the year, sale proceeds should be brought into account. The sale proceeds brought into account for capital allowances purposes is the amount received when the asset was sold to the third party on termination of the lease over and above the expected residual value of the asset ( 75,000-40,000= 35,000). 0) The car is a special rate asset based on its CO2 emissions. The deduction from the special rate pool should be the proceeds received for the sale. ) As the qualifying activity has been permanently discontinued, disposal proceeds equal to the market value of the plant and machinery at the date of cessation are brought into account. 2) A balancing allowance is calculated based on the tax written down value of the main pool and special rate pool, less actual and deemed sale proceeds, at the date of cessation. Part 2 Terminal Loss Relief Calculation Losses should be relieved as follows: 30 June June June June December 205 Trading profits 6,500,000 9,500,000 4,000,000 Chargeable gains,000,000 Loan relationship 20, , ,000 50,000 6,70,000 0,740,000 4,220,000 50,000 Less: Trading (50,000) loss relief current year Less: Trading loss relief carry back from 205 (4,220,000) 2

4 Less: Terminal loss relief from 30 June 205 Less: Terminal loss relief from 3 December 205 Charitable donations relief (20,000) (3,630,000) 7,0,000 (7,0,000) Taxable profit 6,590, Unrelieved charitable donations 20,000 20,000 20,000 30,000 Loss memorandum: Loss in y/e 30 June 205 8,000,000 Less: Trading loss relief in y/e 30 June 205 (50,000) Less: Trading loss relief in y/e 30 June 204 (4,220,000)) 3,630,000 Loss of 30 June 205 available for 36 month c/b: Lesser of 8.000,000 x 6/ ,000 And loss remaining 3,630,000 3,630,000 Less: Terminal loss relief in y/e 30 June 203 (3,630,000) Loss remaining unrelieved - Loss in period 3 December 205 4,690,000 Less: Terminal loss relief available for 36 month (7,0,000) c/b Loss remaining unrelieved 7,580,000 Explanations: Relief for losses arising in the earlier period must be given before relief for losses of a later period. As such, the losses in the year to 30 June 205 must be relieved first. These losses will be relieved firstly under the normal rules for trading losses. The loss can be relieved against total profits of the accounting period in which the loss was incurred and then can be carried back against total profits in the twelve months preceding the accounting period in which the loss is incurred. Total profits means all profits of the company before any qualifying charitable donations. Part of the loss incurred in the period ended 30 June 205 will be a terminal loss as it has been incurred in the final 2 months of trading. A proportion of the loss can therefore be carried back into any accounting periods falling wholly or partly in the three-year period ending prior to July 204. Losses being relieved under terminal loss carry back rules are relieved against total profits. The losses are apportioned based on 6 months of the loss being a terminal loss. The amount carried back under the terminal loss relief rules is the lower of the proportion of losses which are 3

5 available to be carried back under the provisions for terminal loss relief or the amount of loss left unrelieved. Losses are utilised against profits in later periods before those of earlier periods. The loss carried back from 30 June 205 is utilised fully in 30 June 203 and therefore losses arising in 30 June 205 are not available for offset in 30 June 202. The losses arising in the period to 3 December 205 are also terminal losses as they have been incurred in the last 2 months of trading. These can be carried back into any accounting periods falling wholly or partly in the three-year period ending prior to July 205. As such, losses arising in the period to 3 December 205 are not available for offset in the period to 30 June 202. The loss arising in 3 December 205 is offset as far as possible in 30 June 203. Any amounts left unrelieved are lost. MARKING GUIDE FOR Q TOPIC Tax computation: Interest payable treated as trading deduction Share based payment added back s038 CTA 2009 Rental element of finance lease added back s377 CTA 200 Recognise double tax relief available for WHT on royalty Election for expense relief WHT deduction taken Depreciation non deductible Profit on disposal of fixed assets deducted in computation Charitable donations adjustment add back in computation Charitable donations adjustment deductible as paid Charitable donations adjustment unrelieved in current year Capital allowances calculation: Sale proceeds for labelling machine deducted from main pool Car would have been a special rate asset when purchased deduct proceeds from SRA pool Lease for printing press is a long funding lease Calculation of proceeds for purposes of lease and deduction from pool s70e CAA 200 Proceeds on cessation s6() CAA 200 Balancing allowances calculated s54(4) CAA 200 Loss calculations: 30 June 205 losses first (CTA 200 s38(5)) s37 current year s37 carry back 30 June 205 terminal loss relief available and calculation of terminal loss element for 30 June 205 year Terminal loss relief is available against total profits MARKS 3 December month carry back under terminal loss relief Losses remain unrelieved as unable to be carried back to 30 June 202 Charitable donations, other than 30 June 202, remain unrelieved as utilised after loss relief TOTAL 20 4

6 Question 2 Briefing note From: Me, Tax Manager To: Sam Thomas, Tax Partner Research and development ( R&D ) is defined for tax purposes as activities that are treated as R&D in accordance with generally accepted accounting practice. This definition is expanded by the Department of Business, Innovation & Skills ( BIS ) Guidelines, which provide that R&D for tax purposes takes place when a project seeks to achieve an advance in overall knowledge or capability in a field of science or technology. The first project is likely to meet the definition of R&D as it seeks to make an appreciable improvement to a product. The second project is unlikely to meet the definition of R&D as cosmetic and aesthetic qualities are not of themselves science or technology. When R&D is being undertaken, tax reliefs are available. The level of relief depends on whether a company is a small or medium sized entity ( SME ), or large. To be a SME, IS Television System Ltd must, together with any linked or partner enterprises, have fewer than 500 employees, and turnover of less than 00million or a balance sheet total of less than 86million. Incredible Sounds Ltd is a linked enterprise as it holds over 50% of the share capital in IS Television System Ltd. As such, all its results are aggregated with the results for IS Television System Ltd. Best TVs pls is a partner enterprise as it holds between 25% and 50% of the shares in Incredible Sounds Ltd. 30% of its results will be aggregated with the results of IS Television Systems Ltd. Incredible Sounds Ltd IS Television Systems Ltd 30% of Best TVs plc TOTAL Turnover 35 million 0 million 9.5 million 64.5 million Turnover in 45.5 million 3 million million million Balance sheet total 30 million 0 million 2 million 52 million Balance sheet total in 39 million 3 million 5.6 million 67.6 million Number of employees IS Television Systems Ltd will be a SME. In calculating the profits of the trade for Corporation Tax purposes, a SME is entitled to an additional deduction of 30% on the qualifying R&D expenditure. If a SME has a loss for an accounting period, it can make a claim for a cash credit to be paid by HM Revenue & Customs to the company. The cash credit is calculated as 4.5% of the uplifted R&D deduction (or the unrelieved trading loss in the year, if lower). In order to make a claim for the SME R&D tax relief, IS Televisions Systems Ltd would need to be able to evidence that expenditure is revenue and relates to a trade carried on by the company. This would be met in respect of the expenditure on the first project, as the expenditure is deductible against the profits of the trade of IS Television Systems Ltd, that is, selling speakers. 5

7 Expenditure is qualifying expenditure on in-house R&D or contracted out R&D, that is: a) Staff costs this includes gross salary, employer pension contributions and cash bonuses, including class national insurance contributions relating to the 25 workers actively engaged in R&D on the first project. The company car benefit will not qualify. An apportionment of the staff costs should be used as the employees perform duties other than this qualifying R&D. b) Consumables - heat, light and power used up in the R&D process. An apportionment should be used as the heat light and power is used for activities other than this qualifying R&D. Expenditure must not be subsidised or incurred on work subcontracted to the company by another company. This is met as no grants have been received and the work has not been subcontracted. A claim for relief can be made in the Company Tax Return within two years of the last day of the accounting period in which the expenditure was incurred as long as the company is a going concern at the point of making the claim. There is no indication this is an issue. MARKING GUIDE FOR Q2 TOPIC Research and development definition GAAP BIS Guidelines Application ( for each project) SME test Detail of SME limits Inclusion of partner enterprise at 30% Inclusion of linked enterprise at 00% SME Additional 30% deduction available if meet the conditions Possible R&D tax credit of 4.5% Revenue expenditure Relating to a trade Qualifying expenditure on in-house R&D: Staff costs - Can be claimed and should be apportioned - Company car does not qualify Consumable costs Not subsidised Not subcontracted Claim can be made where company is a going concern Claim should be made in tax return Time limit for claim MARKS TOTAL 5 6

8 Question 3 P Smith Esq. Address Tax Advisors LLP Address May 206 Dear Mr Smith Below are the Corporation Tax consequences of the sale of the shares in Sweet Fruit Ltd by Organic Fruit plc to Cool Bananas plc. Gain on disposal of Sweet Fruit Ltd Assuming sale proceeds of 0 million, a chargeable gain will arise: Proceeds on disposal 0,000,000 Less: Cost of shares (500,000) Legal costs on investment (5,000) (505,000) Gain on disposal of shares 9,495,000 Indexation allowance on cost June 5 July 6 [( )/257.4] = x 500,000 (4,500) Indexation allowance on legal costs June 5 July 6 [( )/257.4] = x 5,000 (45) (4,709) 9,490,29 Substantial shareholdings exemption ( SSE ) SSE automatically exempts gains on the sale of shares where three conditions are all met. These are, broadly: - the investing company must hold at least 0% of the ordinary share capital of the investee company for a continuous period of at least 2 months in the preceding two years; - the investing company must be a sole trading company or a member of a trading group for the same period and immediately after the sale; and - the investee company must be a qualifying trading company or qualifying holding company of a trading group for the same period and immediately after the sale. Here, SSE will not be available as Sweet Fruit Ltd will fail to satisfy one of those conditions in that it will not have traded for one year as at July 206 when its shares are sold. Sweet Fruit Ltd became a trading company within the SSE definition when it started preparing to trade in September 205. If commercially practicable, Organic Fruit plc could seek to defer the sale of Sweet Fruit Ltd to October 206. The Warehouse All the subsidiaries of Organic Fruit plc are wholly-owned and therefore all in a capital gains group. Therefore, the transfer of the warehouse from Sour Fruit Ltd to Sweet Fruit Ltd would have been at nil gain/nil loss for tax purposes. 7

9 On the sale to Cool Bananas plc, Sweet Fruit Ltd will leave the capital gains group whilst holding an asset it received under the nil gain/nil loss provisions in the last 6 years and therefore a degrouping charge will arise. This is calculated as if Sweet Fruit Ltd had disposed of and reacquired the asset at market value immediately after the time it acquired the asset from Sour Fruit Ltd, with the cost of the asset being the cost to Sour Fruit Ltd plus indexation up to the date of transfer, as follows: Deemed proceeds on disposal 5,000,000 Less: Cost to Sour Fruit Limited (2,000,000) Indexation to Sour Fruit Limited Dec 0 Sep 5 [( )/228.4] = 0.29 x 2,000,000 (258,000) Degrouping charge capital gain on sale of Sweet Fruit Ltd 8 (2,258,000) 2,742,000 The gain arising from the deemed disposal will be added to the consideration received by Organic Fruit plc for the shares in Sweet Fruit Ltd for the purposes of computing Organic Fruit plc s gain on sale of the shares. However, at the time that Sweet Fruit Ltd purchased the warehouse, it acquired an asset worth 5 million for 2 million and therefore the value of Sweet Fruit Ltd rose by 3 million. This 3 million would effectively be subject to double taxation as part of the degrouping charge and as part of the gain arising on the sale of the shares. As such, a claim can be made to reduce the degrouping charge by a just and reasonable amount because all or some of the degrouping charge has been reflected in the proceeds from disposal of the shares. As the 3 million subject to double taxation is greater than the degrouping charge, a claim should be made to eliminate the degrouping charge. The claim should be made in the Corporation Tax computation for Organic Fruit plc for the accounting period in which the sale of Sweet Fruit Ltd shares occurred. This must be made within two years of the end of the accounting period, that is, by 30 September 208 if the sale is made in July 206. Group relief Prior to its sale to Cool Bananas plc, Sweet Fruit Ltd is part of the group relief group of Organic Fruit plc since it is wholly owned and therefore within the 75% group. Organic Fruit plc and its subsidiaries can utilise the trading losses of Sweet Fruit Ltd until the point where Sweet Fruit Ltd is no longer in a group relief group. This is when arrangements come into force for the sale of the shares in Sweet Fruit Ltd such as where an offer is accepted subject to contract or when shareholders approval is provided (if required). Group relief is available for the period from October 205 to the day when arrangements come into force for the sale of the shares. Both the profits and the losses of Organic Fruits plc/its subsidiaries and Sweet Fruit Ltd respectively will need to be apportioned based on the overlapping period. The maximum amount available for group relief would be the lower of the combined profits of Organic Fruits plc/its subsidiaries or the losses of Sweet Fruit Ltd for the overlapping period. Yours sincerely Tax Manager

10 MARKING GUIDE FOR Q3 TOPIC Calculation of gain which would arise on sale of shares: Proceeds Deduction of cost and fees Indexation Substantial shareholding exemption automatically exempts gain if conditions met Summary of three tests that must all be met Investee company conditions not met Consider delaying sale to October 206 Degrouping: Companies in a capital gains group and previous transfer at no gain/no loss Company leaving group in 6 years holding asset and therefore degrouping charge arises Calculation of degrouping charge Degrouping charge is added to the proceeds of sale of the shares Relief under s79za available Calculation of just and reasonable relief Group relief In a group relief group Relief available until arrangements in place Time apportionment required MARKS TOTAL 5 9

11 Question 4 TO: SUBJECT: Amanda Jones Liquidation of Berlin GmbH - UK CT consequences You asked me to outline the UK Corporation Tax consequences of the proposed liquidation of Berlin GmbH with some funds repatriated to the UK, and other funds on-lent to the US. Repatriation of funds from Germany The distribution of funds following the liquidation of Berlin GmbH will be treated in the UK as a capital disposal by London Ltd in relation to its shares in Berlin GmbH. This will give rise to a chargeable gain in London Ltd, which will be subject to Corporation Tax in the accounting period in which the distribution is made. The repatriation of 0m will be treated as a part disposal by London Ltd with the chargeable gain calculated in Sterling, because the company s functional currency is Sterling. The calculation is as follows: Disposal proceeds 8,000,000 (= 0.8) Base cost 800,000 (= 2,000,000 x 0m / ( 0m ) Gain 7,200,000 An amount of indexation allowance will be available to increase the base cost in-line with inflation, which will reduce the gain. A further gain will arise when the remaining proceeds, together with interest, are repatriated to London Ltd. Based on current values there would be a gain of 3,600,000 ( 7,200,000 * 5 / 0). Movements in exchange rates may increase or decrease the resulting gain. So, for example, if the Euro was to appreciate to 0.90 this would increase the proceeds (and hence the gain) by 500,000 ( 0.9 = 4,500,000 compared with 4,000,000). Loan to the US As a result of the loan from London Ltd to New York Inc., London Ltd will stand in the position of creditor as respect a money debt that arises from the lending of money. This will therefore be a loan relationship in the hands of London Ltd, which are taxed under the loan relationship rules. Under these rules, London Ltd will be subject to tax on all profits arising on the loan (as well as any interest charged). The loan will be an investment for London Ltd so the receivables will be treated as non-trading credits. The UK transfer pricing rules need to be considered as the loan will be interest-free. These rules will apply as the loan between two connected companies, is not on arms length terms and gives rise to a potential tax advantage in the UK. As a result, the UK transfer pricing rules will apply to negate this tax advantage by imputing an arm s length rate of interest. This will be taxed in the UK as a non-trading credit under the loan relationship rules. This could result in a double-tax charge for the group, depending on the US tax position. Under the US-UK tax treaty, it might be possible to make a claim under the mutual agreement procedure in respect of the interest imputed on the loan to mitigate any double taxation. 0

12 As the companies are connected, the profits will be calculated using an amortised cost basis of accounting and no relief will be available for any impairment losses should the debt become impaired. The loan is denominated in US dollars and is being made by a company with a Sterling functional currency. As a result, the loan amount will have to be retranslated in the accounts of London Ltd at each balance sheet date. Corresponding profits and losses should be recognised in the income statement. Exchange gains and losses will therefore arise throughout the life of the loan based on market exchange rates, and will be taxed or relieved in the UK as part of London Ltd s profits or losses from the loan. These will be brought into account as non-trading credits and debits. If in an accounting period, there is an overall non-trading loan relationship deficit (i.e. more debits than credits across all of London Ltd s loan relationships), this can be (i) used against all profits of the accounting period in the UK (including through group relief to other UK group companies); (ii) carried back against non-trading loan relationship profits of the company in the previous year; or (iii) carried forward against future non-trading profits of the company. The initial proceeds of 8m ( 0.8) from Berlin GmbH will be lent by London Ltd to New York Inc. The amount of the loan to New York Inc. in US dollars will depend on the exchange rates at the date the loan is made. Based on the current rates the loan would be for $2m ( 8m x.50). If exchanges rates then move to.60: at the balance sheet date, the loan would be worth 7.5m giving an allowable loss of 500,000 in the UK. If exchange rates move to.40:, the loan would be worth approximately 8.57m giving a taxable gain of approximately 570,000 in the UK. Other points The following needs further consideration: - Berlin GmbH is a controlled foreign company (CFC) for UK tax purposes. A CFC is a company which is not resident in the UK and which is controlled by a UK person or persons. Any of its profits that fall within a gateway will be apportioned to London Ltd and subject to tax at the normal rate of Corporation Tax. This will include interest on funds that originated from the UK. Consideration should therefore be given as to whether one of the exemptions applies, such as the excluded territory exemption. - Berlin GmbH has been making losses and may not be able to fully use these against profits in Germany. Given that the company is being liquidated there may be scope to claim loss relief in the UK for these losses. Cross-border group relief within the European Economic Area (EEA) is available where the surrendering company has exhausted all possibilities for using the loss in its state of residence, and there is no possibility for the company s losses to be taken into account in the future. The ability to claim EEA losses in the UK has various restrictions on it and the availability of these would have to be researched further. Happy to answer any questions you have. Regards Alex

13 MARKING GUIDE FOR Q4 TOPIC MARKS Distribution in winding-up capital Part disposal Calculate gain by reference to sterling functional currency Calculation of the chargeable gain Gain on remaining funds Remaining gain could be higher or lower depending on movements in exchange rates Loan application of transfer pricing to impute interest 2 Loan treaty claim under MAP Loan Definition of loan relationship Loan basic treatment (imputed interest taxed as a NTLR credit) Loan connected company rules Loan taxed on exchange gains and losses, resulting in NTLR debits and credits.5 Loan use of NTLR deficits Loan calculation of profit where US depreciates Loan calculation of loss where US appreciates CFC issues 2 Cross border group relief 2 TOTAL 20 2

14 Question 5 Chris Lane Finance Director Pizza Ireland Ltd Dublin Accountants LLP London May 206 Dear Mr Lane Expansion into the UK Further to our meeting last week, I set out in more detail the UK Corporation Tax (CT) implications of Pizza Ireland Ltd setting up a UK resident subsidiary ( UK Newco ) to expand the restaurant business the UK. UK resident subsidiary As a UK tax resident company, UK Newco will be taxable on its worldwide profits and gains. It will be subject to CT on its taxable profits from when it acquires a source of income, for example by placing money on deposit to earn interest. It must notify HM Revenue & Customs ( HMRC ) of coming within the charge of CT within three months of this. Certain prescribed information must be provided to HMRC, such as the company s name, registration number, address and the nature of business. Failure to notify could result in a penalty being charged based on a proportion of the tax unpaid after 2 months of the end of the accounting period. Companies pay CT on their taxable profits for an accounting period. HMRC will issue a notice to deliver a Company Tax return. Assuming the company prepares accounts for a 2 month period, the return must be made electronically within 2 months of the end of this period (or three months from the receipt of the filing notice if later). CT is generally payable nine months after the end of the accounting period. Where the profits of the company exceed.5 million, tax is paid in four instalments starting six months and 3 days from the start of the period. The company is not required to make instalment payments in the first year it is large, provided its profits do not exceed 0 million. These limits are reduced proportionately if there are a number of active companies in the worldwide group. There is a further exception where the company s profits for a period do not exceed 0,000. Interest and penalties will arise for the late payment of tax. The rate of tax payable is currently 20% for companies. Calculating taxable profits The restaurant business in the UK would be a venture in the nature of a trade. Therefore UK Newco will be taxable on its trading profits, calculated in line with generally accepted accounting principles (either UK GAAP or International Financial Reporting Standards). 3

15 The cost of renting the premises would be deductible for CT purposes in line with the accounting treatment. Costs of fitting out the restaurants Certain expenses are not deductible for calculating the trading profits. In particular, depreciation (the accounting expense taken in respect of capital costs) would not be deductible. Instead, the company can claim capital allowances in respect of qualifying expenditure. Detailed rules exist which determine whether capital expenditure qualifies or not, and the rate of allowances. In particular: Expenditure to the actual building, such as the construction of permanent walls, does not qualify for any tax relief. Expenditure on integral features of the building, such as wiring and air conditioning systems, do qualify at a reduced rate of 8%. Relief would also be available for equipment such as the table and chairs as well the refrigeration and cooking units. This is at the standard rate of 8%. Furthermore, because of the nature of the restaurant business you can also obtain relief for decorative assets provided for customers enjoyment, such as the artwork to be displayed in the dining area. This is at the standard rate of 8% Where equipment is gifted to the UK Newco, allowances will be given based on market value instead of the actual expenditure. All businesses can claim a deduction for the full value of qualifying expenditure up to an Annual Investment Allowance, which is currently 200,000 per annum. This would not, however, apply to the kitchen equipment that will be gifted by Pizza Ireland Ltd to UK Newco. It would typically be advantageous to prioritise expenditure with the lowest rate of allowances (e.g. integral features) in priority to other expenditure, to maximise the acceleration of the relief. Intellectual Property (IP) A special regime applies for the treatment of intangible fixed assets (IFAs). These are assets which are treated for accounting purposes as an intangible asset and which are acquired or created for continuing use for the company s business. This would include trademarks and information or technique having commercial value. The licence will therefore be an IFA. The regime applies to IFAs acquired or created on or after April The exclusive licence to use the IP will be acquired from a related party, and will derive from the underlying IP held by Pizza Ireland Ltd. Given that Pizza Ireland Ltd only started trading in 2006, all of its IP will have been acquired or created after April As a result, the licence will fall within the regime. The company will therefore obtain tax relief for both capital and revenue costs in respect of the licence. The cost of acquiring the licence will typically be deductible in line with the accounting amortisation of the cost over its useful economic life. However, it is permissible to elect to obtain relief on a straight-line basis over 25 years. The annual royalty payments will be deductible in line with the accounts. It is arguable that the royalty payments for the use of the IP constitute an annual payment. However, no withholding tax would need to be deducted from these payments under the Interest 4

16 and royalties directive, given that the payments are made to an associated company in another member state of the EU. No notification is needed to make the payments gross, without deduction. Equity funding The investment by shares will be a capital transaction. As a result, any associated costs (such as legal fees) will be non-deductible for tax. The company will not be entitled to any relief for any dividends paid on the shares. Any payment of dividends will, however, be free of any UK withholding tax. Please do not hesitate to contact me if you have any further questions. Yours faithfully Deidre Reilly MARKING GUIDE FOR Q5 TOPIC MARKS Presentation UK Company UK resident, therefore taxed on worldwide profits UK Company duty to notify UK Company tax return requirements UK Company tax payment dates UK Company tax rate Restaurant business trading profits, calculate by reference to commercial accounts Restaurant business cost of renting space deductible Restaurant business no deduction for capital expenditure / depreciation Restaurant business no allowances for fabric of the building, incl. permanent walls Restaurant business allowances for integral features, including wiring and air con. Restaurant business relief for equipment, including table and chairs, fridge. Restaurant business relief for decorative items, including artwork Restaurant business relief for gift of kitchen assets treated at market value Restaurant business - Annual Investment Allowance* Restaurant business CA rates Intellectual Property definition of Intangible Fixed Asset Intellectual Property within the IFA regime (post-2002 asset) Intellectual Property relief in line with the accounts Intellectual Property no withholding tax (under EU Interest and Royalties Directive) Shares tax treatment regarding costs and distributions, and no WHT on dividends TOTAL 20 *AIA amount as previously agreed with TBs prior to FA (No 2) 205 will also be marked as correct. 5

17 Question 6 Background Under FRS 02, companies should recognise deferred tax for timing differences. Timing differences are differences between taxable profits and accounting profits that arise from the inclusion of income and expenses in tax returns in periods different from those in which they are recognised in financial statements. Unrelieved tax losses and other deferred tax assets shall be recognised only to the extent that it is probable that they will be recovered against the reversal of deferred tax liabilities or other future taxable profits. The very existence of unrelieved tax losses is strong evidence that there may not be future taxable profits against which the losses will be relieved. Deferred tax liabilities and assets should be measured using the tax rates and laws that have been enacted or substantively enacted by the reporting date that are expected to apply to the reversal of the timing difference. Under FRS 02, deferred tax shall not be recognised on permanent differences. Permanent differences arise because certain types of income and expenses are non-taxable or disallowable (e.g. client expenditure), or because certain tax charges or allowances are greater or smaller than the corresponding income or expense in the financial statements. Teacups Ltd Net book value,436,000 Less: Tax written down value (908,000) 528,000 Deferred tax liability at 20% 05,600 Deferred tax liabilities must be recognised. Directors deferred bonuses 200,000 Deferred tax (asset) at 20% (40,000) This deferred tax asset in respect of directors bonuses should be recognised as the company is generally profitable and so it is expected that Teacups Ltd will have sufficient taxable in the future to be able to recover the deferred tax asset. Furthermore, the directors bonuses are expected to reverse before the deferred tax liabilities on accelerated capital allowances. As such, it would be possible to utilise the asset against the deferred tax liability. Saucers Ltd Net book value 56,000 Less: Tax written down value (70,000) (4,000) Deferred tax liability / (asset) at (2,800) 20% 6

18 While the company is currently loss making, future claims for capital allowances will allow the company to surrender group relief to Teacups Ltd and obtain value for these losses. On the basis that Teacups Ltd is profitable and also because it has deferred tax liabilities in excess of this amount, a deferred tax asset for this amount should be recognised. Trading losses c/f 434,000 Deferred tax (asset) at 20% (86,800) The company is currently loss making and if it is unlikely that Saucers Ltd will have future taxable profits against which the losses could be relieved, the deferred tax asset in respect of trading losses carried forward should not be recognised. Recognition would, however, be appropriate to the extent that future projections indicated it is probable the losses will be recovered against future taxable profits. MARKING GUIDE FOR Q6 TOPIC MARKS Timing differences Recognition of deferred tax assets Permanent differences (and so no deferred tax on client entertaining) Measurement Capital allowances calculation of DT liability and recognition criteria.5 Deferred directors bonuses calculation of DT asset and recognition criteria.5 Capital allowances calculation of DT asset and recognition criteria.5 Tax losses calculation of DT asset and recognition criteria.5 TOTAL 0 7