Appealing the Taxing Authorities Implements to the Special Commissioner of Small Companies Associated under Law - Case Study Example

Problem Analysis Research Report CLIENT Alec Smith and Martin Curtis MATTER Tax Relief for Small and Associated Companies/ICTA 1988 6 June, 2009 PROBLEM ANALYSIS The Clients wishes to know: 1. Whether or not their respective companies qualify for full small company tax relief under Section 13 of the Income and Corporation Tax Act 1988. (ICTA) 2. Whether or not Curtis’ company Xavier and Co. Ltd and Smith’s company Young and Sons Co. Ltd. are associated companies within the meaning of Section 13 of ICTA and as such are not entitled to tax relief accorded small corporations. 3. If so, whether or not the fact that Xavier and Co. has not been carrying on active business for many years permits the exclusion of corporate tax rate sharing in respect of small companies. ISSUES I have therefore researched and reported on the following issues: 1. The criteria for full small company tax relief under Section 13 of ICTA. 2. What constitutes associated companies for tax purposes under Section 13 of ICTA. 3. Whether or not an associated company is required to share tax rates when one of the associated companies has not been engaging in active trade for a number of years. REPORT 1 CLIENT Alec Smith and Martin Curtis ISSUE Whether or not the clients’ small companies are entitled to tax relief under Section 13 of ICTA. CONCLUSION Both companies are small companies for the purpose of tax relief under Section 13 of ICTA 1988. Though actual profits are not provided for the relevant tax year, Young and Sons’ annual taxable profits have been consistently deemed eligible for small companies tax relief under Section 13 of the Income and Corporation Tax Act 1988. Xavier and Co. appears to have a similar scenario and its only business activity for many years has been the rental of its old business premises. The assumption based on these facts is that neither company’s profits have catapulted to such an extent over the previous years when tax relief for small companies was allowed. REPORT PRIMARY SOURCES Section 13(1) of ICTA 1988 provides that when any company which is resident in the UK realizes profits for “any accounting period” that does not “exceed the lower relevant maximum amount,” tax will be calculated on a lower rate basis referred to as the “small companies’ rate.” The lower rate is subject to Parliamentary determination. Section 13(2) goes on to provide that in “any accounting period” the relevant company’s profits “exceed the relevant lower maximum amount” but does “not exceed the upper relevant maximum amount” the company is entitled to claim the “corporate tax charged on its basic profits for that period” which shall be subject to deductions equal to “such fraction as Parliament may” determine “from time to time” . Moreover, Section 13(3) provides that where there are no association companies the lower maximum amount is 100,000 pounds and the higher maximum amount is 500,000 pounds. According to HM Custom’s latest Rate of Corporation Tax, as of 2009, the lower taxable maximum amount is 300,000 pounds and the higher taxable maximum amount is 1,500,000 pounds with applicable taxes at 21% while the main rate is 28 %. HM Custom’s report also reflects that small companies realizing profits between 10,000 and 50,000 are entitled to marginal tax benefits between 0 % and 19% tax rates. COMMENCEMENT ICTA 1988, came into force for the tax year 1988-1989 and applied to companies whose accounting year ending after 5th April, 1988. RESEARCH RESOURCES I conducted a search of LexisNexus and Westlaw of the terms “small company tax rates” and was directed to ICTA 1988 Section 13 and HM Customs’ Rate of Corporation Tax. UPDATING Thorough searches in: Current Law legislation Citator for legislation on small company tax rates. There are no changes to ICTA 1988 and all indications that it is current as amended. Current tax rates Citator for current applicable tax rates for small companies. HM Customs’ Rate of Corporation Tax was amended in November of last year and is the most current corporation tax table. REPORT 2 CLIENTS Alec Smith and Martin Curtis ISSUE Whether or not Curtis’s company Xavier and Co. Ltd and Smith’s company Young and Sons Co. Ltd. are associated companies within the meaning of Section 13 of ICTA and as such are not entitled to tax relief accorded small corporations. CONCLUSION Xavier Co. Ltd and Young and Sons are not associated companies for purposes of Section 13 of ICTA 1988. Although the respective owners/part owners of these companies, Smith and Curtis, are civil partners there is no evidence or indication that their one company controls the other or that either Smith or Curtis has control over the other company. Further there is no evidence or indication that Smith and Curtis have colluded to acquire tax benefits by virtue of their respective company holdings making it unlikely that they can be caught by Section 35 of the Finance Act 2008 which amends Section 13 of ICTA so as to expand the definition of control. It therefore follows that there is no legal basis for the companies to be characterized as associated companies. REPORT PRIMARY SOURCE Two parts of ICTA 1988 are relevant for determining whether or not Xavier and Young are associated small companies and the tax consequences that follow from this determination. Section 13(3) fixes the lower relevant maximum amount at 100,000 pounds “divided by one plus the number of those associated companies” while the upper relevant maximum amount is fixed at 500,000 pounds “divided by one plus the number of associated companies.” In the event the relevant company is not attached to an associated company or companies, the amounts are fixed at 100,000 pounds and 500,000 pounds. Section 13(4) provides that a company is regarded as an “associated company of another” if at the relevant time “one of the two has control of the other or both are under the control of the same person or persons.” Section 416 of ICTA 1988 defines “control” as follows: “The ability to exercise or to acquire control, whether direct or indirect, over the company’s affairs. It includes the possession of, or the right to acquire: (a) The greater part of the share capital or issued share capital; or (b) The greater part of the voting power; or (c) So much of the issued share capital as would give the right to receive the greater part of the company’s income, were all that income distributed; or (d) Rights to the greater part of the company’s assets in a distribution on a winding-up or in any other circumstances.” Section 35 of the Finance Act 2008 amends Section 13 so as to permit tax inspectors to take account of associated persons or partners of another company with whom a small company owner colludes with for tax purposes. In the entire context of Section 13, these amended can only apply to a situation in which the associated person and his or her company are commercially connected to the relevant small company. COMMENCEMENT ICTA 1988, came into force for the tax year 1988-1989 and applied to companies whose accounting year ending after 5th April, 1988. The Finance Act 2008 came into force for the tax year 2008-2009. RESEARCH RESOURCES LexisNexus Butterworths UK Parliament Acts-searched for ICTA 1988 and subsequent relevant amendments. UPDATING The legislation database revealed ICTA 1988 and Section 35 of the Finance Act 2008. REPORT 3 CLIENT Alec Smith and Martin Curtis ISSUE Whether or not an associated company is required to share tax rates when one of the associated companies has not been engaging in active trade for a number of years and whether or not mere receipt of rents can be characterized as carrying on business. CONCLUSION Xavier cannot be treated as an associated company under Section 13 of ICTA 1988 because the collection of rent from its former business premises is not active participation or management of its business and does not amount to anti-avoidance tax measures. REPORT PRIMARY SOURCES Section 13 of ICTA provides for an associated person test which necessarily requires business activities. The test has been applied by the High Court in HMRC v Salaried Persons Postal Loans Limited [2006] EWHC 763 (CH). In this case, the defendant had ceased all business activities and merely collected rents from a tenant who occupied the defendant company’s former business premises. In order to successfully appeal the Special Commissioner’s tax finding with respect to an associated company’s dormancy status, the appellant must prove that the Special Commissioner was misdirected as a matter of law or could not have, on the facts, reasonably reached the conclusion that he or she did. (For further information see Edwards v Bairstow (1955) 36 TC 207) As Lord Diplock stated in Town Investments Ltd. v Department of the Environment [1978] AC 359 whether or not a particular scenario amounts to carrying on business is a matter of context and fact. In this regard, if Xavier is not a rental or real estate company, it is highly unlikely that renting its business premises will amount to active rather than passive business conduct. COMMENCEMENT ICTA 1988 came into force for the tax year 1988-1989 and applied to companies whose accounting year ending after 5th April, 1988. There is no commencement date for cases. RESEARCH RESOURCE LexisNexis Butterworths UK Parliament Acts – searched for ICTA 1988 and amendments. Further research was conducted for case law under associated companies/tax rates/dormant business and HMRC v Salaried Persons Postal Loans Limited [2006] EWHC 763, Edwards v Bairstow (1955) 36 TC 207 and Town Investments Ltd. v Department of the Environment [1978] AC 359 appeared to be the most relevant cases. UPDATING The Legislation database revealed the relevant amendments to ICTA 1988 under the Finance Act 2008. REVIEW OF RESEARCH It appears that the taxing authorities erred in their findings that both Young and Xavier are not entitled to tax benefits under Section 13 of ICTA. The presumption is that they concluded that as civil partners, Curtis and Smith colluded for tax benefits and as such the expanded definition of control within the meaning of Section 13 as amended by the Finance Act 2008 rendered the companies associated companies. In this regard, the taxing authorities misdirected itself on the law. Moreover, since the facts of Xavier’s case and the case of HMRC v Salaried Persons Postal Loans Limited [2006] EWHC 763 are virtually identical it is unlikely that an appeal against the taxing authorities decision will fail. It is also likely that the special commissioner will find that Xavier, a dormant company for all intents and purposes, is not an associated company. Therefore tax exemptions under Section 13 ought to apply to both Xavier and Young. ADVICE Both Curtis and Smith should appeal the taxing authorities’ findings to the special commissioner on the grounds that they are small companies within the meaning of ICTA 1988 and are not associated companies under the Act or under case law. The appeal will request an appropriate reduction of the applicable tax in accordance with HM Custom’s latest Rate of Corporation Tax. Read More