UK Taxation System for Companies - Essay Example

UK Taxation System for Companies Answer The UK taxation system employs a Corporation Tax on companies against an individual tax on individuals. Taxes in the Corporation Tax are slightly different in their rates as well as in their application. For the purpose of this report it is necessary to grasp the importance of the term Capital Expenditure. According to Tutor2u, capital expenditure is any expenditure incurred to purchase or acquire fixed assets. Also any cost incurred in the fixed asset’s capability to improve the earning capacity is also a part of capital expenditure. Since this expenditure is not an operational variable, it is charged in the balance sheet as an asset rather than expenditure in the profit and loss account. However, usage of the fixed asset over time is shown in the profit and loss account as a depreciating charge. Tax is applicable for companies on profit figure at the end of the tax year. Since the tax is fixed rate, the higher the profit the company shows, the higher tax it has to pay. Therefore to evade paying higher taxes, companies understate their profits by depreciating their fixed assets on a high value. This reduces the profit and hence the tax payable. Since this practise promotes immoral and unfair picture of the accounts, the government of UK introduced the concept of Capital Allowance through corporation tax. The case of IR Commrs vs Duke of Westminster (1936), exactly points out this need where it states that everyone “is entitled, if he can, to order his affairs, so that the tax attaching under the appropriate acts is less than it would otherwise be”. Capital Allowance The government has fixed a rate of relief that is received on the purchase of capital goods. Companies can claim this type of tax relief when buying and investing. In practice this does the exact same thing a depreciation does since a company is able to set off a proportion of the costs of purchases against the profits it makes so that the total tax bill is reduced. Most capital allowances allow you to write off a percentage of the value of the asset against profits over several years. They are available at a variety of rates and these rates depend on the product bought, the time it was bought in, the nature of the asset and the size of your business. (Georgina, 2006; S. J. D. 2007) Tax Relief As mentioned in the previous section, tax relief can be claimed by companies on the purchase of capital goods. According to the Business Links Website, these capital allowances are available on three types of products, plant and machinery, buildings and research and development. However a company cannot claim tax relief on the items which the company is doing business in. For example a company has a business of selling air conditioners. For this company, these sales are not tax relieved as air conditioners are not a capital expenditure for this company. For a company who deals in selling insurance will consider a purchase of air conditioner as a capital expense and can claim tax relief. It is important to note that different rates apply for each kind and type. A list of the rates is given in the end of this section. Capital Allowance on Plant and Machinery Items that are included under this heading are the cost of vans and cars, machines, scaffolding, ladders, tools, equipment, furniture, computers and similar items are used in the business. Also any expenditure done on plant and machinery is also a capital expenditure. (Business Links Website) Since the definition as to what is included in ‘Plant and Machinery’ to claim tax relief, a number of legal tests have been developed that can be applied to determine what is allowable. A general guide was provided by Lindley LJ, in the case of Yarmouth vs France (1887), where Lindley suggested that plant could be defined as “whatever apparatus is used by a businessman for carrying on his business - not his stock-in-trade, which he buys or makes for sale; but all goods and chattels, fixed or moveable, live or dead which he keeps for permanent employment in his business”. 25% is the standard rate applied in the case of buying equipment. This rate will be decreased to 20% in the year 2008. Rates for small, medium and large firms are different. Also these companies are eligible for first-year allowance which is generally much higher than the normal rate. (Business Links Website) From the 2008/09 tax year, all businesses will have an Annual Investment Allowance on the first £50,000 of expenditure on plant and machinery. At the same time there will also be a tax credit for losses incurred through capital expenditure on some types of environmentally friendly technologies. (S. J. D. 2007) Capital Allowance on Buildings Capital allowances can be availed on the cost incurred to construct industrial, commercial or agricultural buildings. Also any cost incurred to renovate or change a building so it facilitates the manufacturing or trading process can also be claimed for allowances. A standard rate of 4% can be received on the cost during all years. A 100% rate can be received on the construction cost of commercial and industrial buildings in enterprise zones. Those buildings that are not in the enterprise zone can get written-down allowances. This allowance will eventually be phased out by the year 2011. (S. J. D. 2007; Business Links Website) Capital Allowance on Research & Development Capital allowances for capital expenditure on assets used in research and development can be claimed. But it is important to verify that actives are indeed a part of research and development and involves innovation and creativity in science and technology. A 100% write off in the year the expenditure is incurred can be claimed for allowance on research and development. Apart from this the current enhanced rate of 150% for small and medium companies will be increased to a rate of 175% by 2008. In the case of a large company, the rate will be increased from 125% to 130%. (McNeill, 2007) Main Capital Allowances Motor Cars On reducing balance (max. £3,000 p.a. per car) 25% Plant and Machinery (Small firms) Allowance for the first year (to 31 March 2008 for companies) 50% Writing down allowance on reducing balance 25% Plant and Machinery (Medium sized firms) Allowance for the first year 40% Writing down allowance on reducing balance 25% Plant and Machinery (Large firms) Writing down allowance only on reducing balance 25% Long Life Assets Allowance for first year 6% Writing down allowance for coming years on reducing balance 6% Energy Saving Technology All firms 100% Cars emitting not more than 120 g/km C02 Registered 17 April 2002 - 31 March 2008 100% Buildings Industrial buildings and qualifying hotels 4% of building cost p.a. Commercial/Industrial buildings in an enterprise zone 100% of building cost Agricultural buildings 4% of building cost p.a. Business premises renovation allowance (from 11 April 2007) 100% Research and Development Relief 130% or 175% Flat conversions 100% Know how writing down allowance on reducing balance 25% Patent rights (Writing down allowance on reducing balance) 25%  Disadvantaged areas - renovation of business premises 100% Source: (S. J. D. 2007) Answer 2) In the case of companies, any gains or losses arising from the sales of fixed assets will be charged tax. This is called the Corporation Tax on Chargeable Gains. Chargeable gains are the profits that a company makes when it disposes off any asset owned and used by the business. This does not include any items which are bought and sold as part of the normal trade. (Business Links Website) Companies are not liable to capital gains tax but instead they are liable to corporation tax on their net chargeable gains. This figure is calculated in much the same way as individuals’ capital gains. This type of tax applies to company shares as well as other assets. If capital losses have been incurred in the process of disposal, capital gains can be offset by capital losses of the same accounting period or from previous periods. (Business Links Website) Where a company decides to dispose off its capital expenditure products, companies capital gains are subject to Corporation Tax at the normal rates with no annual exemption. These companies continue to receive indexation relief on gains and but do not receive taper relief which relates to the qualifying period of ownership of the asset. (Dyer Partnership) As mentioned above, the sales of shares in also included in the calculation of chargeable gains. But companies are subject to different identification rules from individuals for disposals of shares and securities. A company having substantial holdings of at least 10% are exempt from tax. Also the vendor and the company being sold must satisfy a trading condition and the vendor must have owned the shares for at least 12 months. (Dyer Partnership) In the Indian CIT Vs Brahmi Investments Private Limited case, the taxpayer was a wholly owned subsidiary of a company named ‘KPPL’. KPPL had become a parent to have another wholly owned subsidiary when it acquired all 11,100,000 shares of a company named ‘A’ at a cost of INR 11,100,000. Thereafter, all the shares of company ‘A’ were transferred by KPPL to the taxpayer company at INR 5,536,680. As a result, company A became wholly owned subsidiary of the taxpayer company. Eventually, Company A went into voluntary liquidation and distributed assets valued at INR 9,324,000 in favour of the taxpayer company. The Tax Officer sought to levy Capital gains tax on the said value of assets distributed to the taxpayer after adjusting the cost of INR 5,536,680 incurred by the taxpayer company in acquiring the shares of company A. The first appellate authority partially accepted the contention of the taxpayer that INR 11,100,000 i.e. the cost incurred by KPPL in acquiring shares of company A, should be taken as the cost of acquisition for the taxpayer company. As the Tax Tribunal dismissed the appeal filed by the Tax Department against the decision in first appeal, the matter went to Gujarat High Court on a reference requested by the Tax Department. The Gujarat High Court observed that the distribution of assets by company A to the tune of INR 9,324,000, on its liquidation, should be taxable in the hands of the taxpayer company. Further, it was also appreciated that the shares of company A became the assets of taxpayer company by virtue of transfer by KPPL and therefore its cost of acquisition of INR 11,100,000 should be rightfully taken as the cost of acquisition of the shares of company A for the taxpayer company. In cases where the company assets have to be replaced, a roll over relief can be claimed. Rollover relief allows the vendor of an asset to rollover the gain, or part of the gain against the cost of a replacement asset. The important point to take care of is that both assets must fall into one of eight classes of assets. (Martin, 2007) Answer 3) The government of UK has been giving various sorts of tax relief in the form of capital Allowances to the companies. The primary reason for doing this is to encourage the investment in further capital assets. The government’s interest in doing so is to increase the business sector’s performance and, promote higher and quicker usage of resources to increase productivity. For this very purpose the policy makers have launched the Enhanced Capital Allowances Scheme. This scheme enables businesses to claim 100% first year capital allowances on investments in technologies and products that encourage sustainable use. This will be huge boost to the companies as all the cost incurred on these items will be reimbursed making the cost very low. Such a move helps organisations invest in energy saving equipment in a cost-efficient way. Also the government supports the usage of clean and environment friendly products sp this scheme will also promote this motive of the government. J Sainsbury plc which is a major retailer in UK has recently made use of these allowances and is reaping the benefits already. I believe such schemes and further allowances in other capital goods will certainly increase the investment in capital assets of the companies. The rationale behind this is that the companies would be longer be afraid of the high costs so they would invest more. Since the basic aim of any company is to increase its profits, a heavier investment will improve the business processes, its products and its services, and hence an increase in profits. (Business Costs Consultants) Works Cited “Capital Allowances: the basics”, Business Links, Accessed on October 27, 2007 from http://www.businesslink.gov.uk/bdotg/action/detail?r.l1=1073858808&r.l3=1073868259&type=RESOURCES&itemId=1073789928&r.l2=1073859194&r.s=sc “Capital Expenditure”, Accounting Glossary, Tutor2u, Accessed on October 27, 2007 from http://www.tutor2u.net/newsmanager/templates/?a=1375&z=82 “Capital gains by companies”, Dyer Partnership, Accessed on October 27, 2007 from http://www.dyerpartnership.com/corptax.html CIT Vs Brahmi Investments Private Limited, Law Case “Corporation Tax: the basics”, Business Links, Accessed on October 27, 2007 from http://www.businesslink.gov.uk/bdotg/action/detail?r.l1=1073858808&r.l3=1073870572&r.t=RESOURCES&type=RESOURCES&itemId=1073790827&r.i=1075091650&r.l2=1073859200&r.s=sc “Enhanced Capital Allowances”, Business Costs Consultants, Accessed on October 27, 2007 from http://www.businesscostconsultants.co.uk/enhanced-capital-allowances.shtml Georgina, Harris (2006). “Capital Allowances”, Accessed on October 27, 2007 from http://www.hie.co.uk/article-0154.html IR Commrs vs Duke of Westminster (1936), Law Case Martin, Nichola Ross (2007), “Rollover relief”, Accessed on October 27, 2007 from http://www.accountingweb.co.uk/cgi-bin/item.cgi?id=159347&d=1025&dateformat=%25o-%25B McNeill, Hugh (2007), “The Entrepreneurs Guide to Tax Relief”, Accessed on October 27, 2007 from http://www.southamptonhub.com/nuts_bolts/tax_relief.asp S. J. D. (2007), “Capital Allowances”, claiming tax relief on your capital expenditure, Accessed on October 27, 2007 from http://www.sjdaccountancy.com/content/taxcentre_yetg/claiming_tax_relief.html S. J. D. (2007), “Main Capital Allowances”, Accessed on October 27, 2007 from http://www.sjdaccountancy.com/content/taxcentre_taxcard/allow.html Yarmouth vs France (1887), Law Case Read More