RELEVANT TO FOUNDATION LEVEL PAPER FTX (UK)
Corporation tax
This article is written to assist candidates in approaching and succeeding in
Question 2 of the Foundations in Taxation (FTX) (UK) exam. It is relevant to
those of you taking Paper FTX (UK) exam in either June or December 2013,
and is based on tax legislation as it applies to the tax year 2012–13 (Finance
Act 2012). It will cover the common areas of corporation tax and will highlight
the common errors and pitfalls made by those taking the exam. It will not
cover any area outside of the Paper FTX (UK) syllabus.
Question 2 of the FTX (UK) exam is always a 15-mark corporation tax question.
It will normally require candidates to compute the corporation tax payable by a
UK-registered company based on given information. Much of the information
given will be standard detail that most UK companies will have to deal with in
every accounting period.
MAIN ISSUES
The first problem is that some candidates confuse a company assessment and
that of an individual. This may be due to exam pressure; however, the question
will always make it clear that it is a company (plc or Ltd) – there should never
be a doubt. When doing a company assessment all income and gains are
assessed in one total column, the breakdown of income into the three
categories of non-savings, savings and dividend relates to individuals only,
never companies. On a similar note, companies do not get personal allowances
or the annual exempt amount for capital gains.
Trading income
The first entry in the assessment is always the trading income. This figure
comes from the trading activities of a company and may be given as ‘adjusted’
or ‘unadjusted’. It is vital that candidates ensure that they check whether the
figure given in the question is before or after adjustments – many candidates
adjust the figure given when it does not require adjusting.
When the term ‘trading profits after the deduction of…’ is used, then this
indicates that the profit figure needs adjusting to arrive at the taxable trading
income. Whereas when the terms ‘trading income’ or ‘adjusted trading profits’
are used, then this indicates that no adjustment to the figure is required.
Occasionally, the question will state ‘adjusted trading profit before interest and
capital allowances’ – this term will mean that the profit has been partially
adjusted but will need further adjustment for the interest and capital
allowances given.
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If capital allowances are not already deducted from the trading income figure
given, but are given separately, then these must be deducted from the trading
profit and not from any other income. If they are deducted elsewhere in the
assessment no mark will be awarded for the deduction.
If the question contains detail of a trading loss brought forward from a
previous period, then this loss must be deducted from the trading income
figure (after capital allowances), and nowhere else in the assessment. Once
again, failure to deduct the figure in the correct place will result in no mark
being awarded.
Interest
Candidates must decide whether the interest figures given are for trade
purposes or for non-trade purposes. In the Paper FTX (UK) exam all interest
received should be treated as non-trade. Interest payable, however, may be
either. Either the question will state that the interest paid is trade or non-trade,
or it will give enough information to enable the candidate to make the correct
decision.
If the interest payable is trade interest, then it must be included in the
calculation of trading income. Non-trade interest payable, however, must be
pooled with interest received to give one net figure. This is then included in the
corporation tax assessment as ‘interest income’. Failure to net the figures
together and, thus, show two separate figures in the assessment will result in
the loss of marks.
The netting of interest receipts and payments will not, in the Paper FTX (UK)
exam, ever result in a deficit, as this area is outside the syllabus.
Both trade interest and non-interest must be calculated on the accruals basis.
Candidates must check the information given and calculate the correct amount
to be included in the chargeable period given in the question.
Companies pay and receive interest gross to/from other companies or UK
banks and, therefore, the figures given in the question will not need grossing
up. Many candidates mistakenly gross up all interest by 100/80. Only that
income paid or received to/from individuals will need grossing up. The
question will clearly state if interest is paid or received to/from individuals – if
it is does not say, then candidates should assume it is from other UK
companies and should not, therefore, gross up the interest.
Property business income
This includes all income from rental properties. It must be calculated on the
accruals basis and, therefore, candidates should ensure that they include any
rent outstanding for the period – the actual date of payment is irrelevant, it is
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taxed in the year that it is due. The calculation is identical to that for
individuals with the exception that interest payable is not a deductible expense,
but is treated as non-trade interest as described in the previous paragraphs.
If the calculation results in a property loss, then that loss must be deducted in
the same year against the total profits before qualifying charitable donations. If
all of the loss cannot be used in this manner, then it can be carried forward to
the following year, against total profits before qualifying charitable donations.
If the loss is deducted in the wrong place – for example, against next year’s
property business income – then full marks will not be given.
Chargeable gains
Chargeable gains of a company are treated like any other income of a company
and are included in the corporation tax assessment – companies do not pay
capital gains tax. The question will normally give the actual amount of the
capital gain but may sometimes require the candidate to calculate the figure
(see below). All gains must be aggregated. If capital losses are given, either for
the same period or carried forward from an earlier period, then these losses
must be deducted from the aggregated gains to give a net chargeable gains
figure. Once again if capital losses are deducted from the wrong income full
marks cannot be awarded. Candidates should note that companies are not
entitled to the annual exempt amount.
Qualifying charitable donations
Donations made by a company to a charity in the Paper FTX exam are always
to be treated as qualifying charitable donations unless they are small amounts
to a local charity, in which case they should be included as a deduction in the
trading income figure. Donations are always made gross and, therefore,
candidates must not gross the payment up as they would for an individual. The
payment must be deducted from total profits (after current year trade and
property business losses); they should not be deducted elsewhere in the
assessment otherwise full marks cannot be awarded.
Taxable total profits (TTP)
This is the term used for the total of all of a company’s income and gains less
qualifying charitable donations. This figure is the figure that the relevant tax
rate will be applied to.
Dividends
Dividends payable are not allowable deductions and should always be ignored
when calculating tax payable. Dividends received are not taxable; however,
dividends from non-associated companies (see below) are grossed up by
100/90 and called franked investment income (FII) before being added to the
taxable total profits to give augmented profits.
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Augmented profits (AP)
This figure determines the rate of corporation tax. The rate of tax is never
applied to this amount. Candidates must always calculate the AP to determine
the rate of tax but be careful to then apply the rate to the TTP.
Tax limits
The tax limits are given in the tax tables included in Paper FTX (UK). If a
company’s AP are £1,500,000 or above, then the main rate of tax (24%) is
applied to the TTP to give the tax payable. If the AP is £300,000 or less, then
the small profits rate of tax (20%) is applied to the TTP. Where AP is between
the two limits, then the main rate is applied to the TTP and then marginal relief
is deducted. The marginal relief formula is always given in the tax tables
supplied in the Paper FTX (UK) exam. Candidates should note that you never
used the marginal relief deduction when the small profits rate of tax is used.
Adjustment of tax limits
Before the rate of tax is determined the tax limits may have to be adjusted.
They are adjusted for two reasons:
• Where the chargeable period is less than 12 months the limits should be
reduced to reflect the length of the period – for instance, an eight month
period will result in limits of £1,000,000 (£1,500,000 x 8/12) and
£200,000 (£300,000 x 8/12).
• If a company has associated companies, then the two tax limits are
divided equally between all companies in the ‘associated group’ – for
instance, if a company has two associated companies, then both the tax
limits are divided by three to give each company limits of £500,000 and
£100,000.
Candidates should take care in checking for both situations. A company with
two associated companies and an eight month chargeable period will have
limits of £333,333 (£1,500,000/3 x 8/12) and £66,667 (£300,000/3 x 8/12).
Candidates are reminded in checking both of these situations before
determining which rate of tax to apply.
Associated companies
Candidates must not confuse the taxation definition of an associated company
with the accounting definition. For tax purposes a company is associated with
another if it is controlled by that company or both are under the control of the
same person or persons (this may be a company or individual). Control here
means holding over 50% of the share capital or voting power or being entitled
to over 50% of the distributable profits or the net assets in a winding up. The
exam question will always make it clear if there is an associated company, but
candidates must be aware this may be by stating that a company holds various
holdings of shares in different companies – only those with holdings over 50%
will be classed as associated companies.
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A typical question may say that A Ltd holds 70% of the shares in S Ltd and
40% of the shares in T Ltd. If this is so, then only S Ltd is an associate
company and the tax limits would therefore be divided by two. Note that
dividends received from S Ltd would be ignored for all tax purposes, but
dividends from T Ltd would be grossed up by 100/90 and included as FII.
OTHER ISSUES
Chargeable gains
As mentioned above, the figures for chargeable gains and losses will usually be
given in the question. On occasion, however, the question may require the
candidate to calculate the gain. In a typical question this calculation will be a
basic gain – technical calculations will be examined in a separate capital gain
question. Candidates are reminded that companies get a deduction for
inflation, called indexation allowance, in calculating chargeable gains.
Indexation factors will always be given – not retail price indexes.
Example:
A Ltd sold a factory in December 2012 for £350,000, which had cost the
company £100,000 in May 2001 and had been improved at a cost of £30,000
in June 2002.
Indexation factors are:
May 2001 to December 2012: 0.350
June 2002 to December 2012: 0.331.
The resulting gain would then be:
Proceeds
Cost
Improvement
Less indexation allowance:
£100,000 x 0.350
£20,000 x 0.331
£
350,000
(100,000)
( 30,000)
220,000
( 35,000)
( 6,620)
178,380
Capital losses, of this year or brought forward, would then be deducted from
the gain before the net amount is included in the corporation assessment. No
reliefs such as rollover relief will be examined in the question – rollover relief
and any other reliefs will be examined separately.
Capital allowances
Capital allowances will be treated in a similar way to capital gains in that the
amount will usually be given, but on occasions they may have to be calculated.
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The full calculation of capital allowances is outside the scope of this article but
candidates must ensure they are aware of all the rules as shown in the
recommended text.
A common mistake made is for candidates to deduct capital allowances from
capital gains – this is wrong as they are totally different areas. Capital gains
are the profits on the sale of assets, whereas capital allowances are ‘tax
depreciation’ – they should not be mixed together.
Periods exceeding 12 months
A UK company can never have a corporation tax assessment for a period in
excess of 12 months. If a company has an accounting period for more than 12
months, then corporation tax must be calculated as if there were two separate
periods of 12 months and the balance. As an example: if a company makes up
accounts for the period 1 January 2012 to 31 March 2013, then two tax
calculations have to be done – one for 1 January 2012 to 31 December 2012
and another from 1 January 2013 to 31 March 2013. No other split of the
period is allowed – you cannot do a calculation, for instance, of the first three
months and then the remaining 12 – it has to be the first 12 and then the
remaining period – three months in this example.
The calculations should be done with the two periods side by side in columnar
format and a calculation for each period shown – the totals should not be
added together. Care must be taken to ensure that income and expenditure
goes into the correct period, especially when it relates to amounts that are in
arrears or advance. Candidates are advised to check the recommended text to
ensure they are aware of the correct method of allocating the different types of
income and expenditure to the correct period.
Date of payment
Usually the question will ask for the date(s) of payment. For any company not
paying tax at the main rate the due date of payment is not later than nine
months and one day after the period end (remember for long periods there are
two separate periods and, therefore, two separate tax payment dates). A
company preparing accounts to 31 December 2012 will therefore have a due
date of 1 October 2013 not 30 September 2013. No mark will be awarded for
near misses or dates without the year stated or simply statements such as
October 2013.
For companies paying tax at the main rate, then the quarterly payment system
is used whereby the company has to pay its tax quarterly on the 14th day of
month seven, 10, 13 and 16 from the start of the period. The tax for the year is
simply divided by four and equal amounts are paid on each of the above dates.
Quarterly payment dates for short periods will not be examined.
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CONCLUSION
Candidates must prepare properly for this type of question. Practice of past
questions will give candidates ample experience of these questions, which will
stay in the same format and standard until future revisions of the Paper FTX
syllabus.
Written by a member of the Paper FTX examining team
© 2013 ACCA