Corporation Tax and VAT

Question 1

The VAT charge

Answer 1

VAT is charged on

· any supply of goods or services made in the UK

· where it is a taxable supply

· made by a taxable person

· in the course or furtherance of any business carried on by that person.

Question 2

VAT Terminology

Answer 2

Supply of Goods or Services: Any supply made in the UK of goods or services done in return for consideration.

Made in the UK: The place of supply of the relevant goods or services must be in the UK. There are complex rules for working out the place of supply for VAT purposes in cross-border transactions, which are outside the scope of these materials.

Taxable supply: Any supply made in the UK which is not an exempt supply. See below for the various types of supply.

Taxable person: A person who is, or is required to be, registered for VAT purposes. ‘Person’ includes individuals, partners, companies and unincorporated organisations.

In the course or furtherance of any business carried on by him: ‘Business’ is a very wide term and basically any economic activity carried on, on a regular basis. An employee’s services to an employer are excluded. All of a person’s business activities are included in one VAT registration.

Question 3

Registration

Answer 3

A person is required to be registered:

at the end of any month if the value of his/her taxable supplies in the period of one year or less has exceeded the VAT registration threshold (the person must notify HMRC within 30 days of the end of that month and will be registered from the beginning of the second month after the taxable supplies went over the threshold); or

at any time if there are reasonable grounds for believing that the value of his/her taxable supplies in a period of 30 days then beginning will exceed the VAT registration threshold (the person must notify HMRC within the 30 days and will be registered from the beginning of the 30 days).

Please note that the registration thresholds (and the deregistration threshold as referred to later) change from time to time. The current registration threshold is £85,000.

Alternatively, a person can register voluntarily. Voluntary registration means that input VAT can be recovered (which is helpful to a business in reducing costs). However, it also means that the business will have to charge output VAT on supplies of goods and services to its customers (which may make the business less attractive to customers than its unregistered competitors).

Question 4

De-registration

Answer 4

A VAT registered person may apply to have the registration cancelled and accordingly cease to be ‘taxable’ (even though continuing to carry on the business) where the value of his/her future annual taxable supplies will not exceed the VAT deregistration threshold. The current deregistration threshold is £83,000.

Question 5

Output and input tax

Answer 5

Output tax

The VAT chargeable by a business when making a supply of goods or services is called ‘output’ tax. The VAT relates to the ‘output’ of the business.

Input tax

The VATpaidby a person on goods or services supplied to the person is called ‘input’ tax. The VAT relates to goods and services ‘bought in’ by the person.

A VAT registered business offsets input tax it has suffered (on goods and services it has purchased) against output tax it has charged customers or clients (on its own supplies) and only accounts for the difference to HMRC.

The business acts as a tax collector in collecting and paying to HMRC the tax on the value added by the business in the supply chain.

Note that where there is no output tax charged in any VAT accounting period, it is still usually possible to reclaim any input tax incurred where it is intended output tax will be charged in the future.

Question 6

How much VAT?

Answer 6

The applicable rate of VAT will depend on the type of supply. The standard rate of VAT is currently 20%.

A price is deemed to be VAT inclusive unless the contract for the supply of goods or services states otherwise. In other words, the stated consideration paid for the supply includes any VAT payable.

Where the standard rate of VAT applies, in order to calculate the VAT element of a VAT inclusive price you should multiply the price by the VAT fraction, which is currently 1/6. This has been worked out as follows:

Tax rate = 20 = 1

100 + tax rate 120 = 6

The seller must account for the VAT element amount to HMRC, so the seller won’t be allowed to keep the full amount of the stated price. In practice, the seller can deduct any input VAT that it has incurred so it only needs to pay HMRC the difference.

In many situations it will be appropriate for the price of goods or services to be expressed as exclusive of VAT so that VAT is charged in addition to the stated price. Here, the seller will account to HMRC for the VAT element and keep the (VAT-exclusive) stated price.

Question 7

Types of Supply

Answer 7

1. Standard Rated

Generally, the standard rate of VAT is 20%. A supply by a business will be standard rated unless it falls within one of the other three categories.

A VAT registered business charges VAT at standard rate on its outputs and recovers any VAT suffered on its inputs (unless it makes supplies which fall into the exempt category below).

2. Reduced Rated

A very limited number of types of supply are charged at 5%. These include supplies such as domestic heating and power, installation of mobility aids for the elderly, smoking cessation products and children’s car seats.

3. Zero Rated

Further supplies are zero rated for public policy reasons. Zero rated supplies include food (within certain categories), sewerage and water, books / newspapers, talking books for the blind, new houses and the construction of new houses, public transport and children’s clothing.

Zero rated supplies fall into the category of taxable supplies. This means that when a VAT registered business makes zero rated supplies it charges VAT at the rate of 0% on its outputs and it can recover any VAT suffered on its inputs. This is therefore a very favourable supply for a business to make.

4. Exempt

Supplies that are exempt include the provision of insurance, finance, education / health services and the sale of land and buildings (unless it comprises a new commercial building or the supplier of a commercial building has chosen to make the supply standard rated by waiving the exemption). When a business makes exempt supplies it does not charge VAT on its supplies but equally it is notable to recover any VAT suffered on its inputs. This input tax is a cost to the business.

Question 8

Accounting for VAT to HMRC

Answer 8

1. VAT Invoice

A taxable business making a standard (or reduced) rate supply of goods or services to another taxable business must supply the customer / client with a VAT invoice within 30 days of the supply and keep a copy. HMRC carries out regular inspections of businesses to ensure that input and copy output invoices have been kept.

2. VAT Return

Taxable businesses must submit a VAT Return online to HMRC every three months. The due date is usually within one month and seven days after the end of the VAT period.

The VAT Return must show the total output tax charged on the making of taxable supplies during that VAT period less the total input tax attributable to the making of taxable supplies. At the same time the business must pay to HMRC the excess of the output tax charged over the input tax suffered.

Businesses that normally pay more than £2.3 million a year to HMRC in VAT must make monthly payments on account and then pay the balance when submitting the quarterly VAT return.

3. Special Schemes

There are a number of special schemes designed to simplify accounting for VAT or to reduce VAT liability:

• Retail Schemes

There are special schemes for use by retailers who find it difficult to issue VAT invoices for the large number of supplies that they make direct to the public.

• Cash Accounting

Businesses whose annual turnover is less than £1,350,000 (excluding VAT and excluding exempt supplies) may opt to use a cash accounting scheme if they comply with certain conditions, i.e. output tax is accounted for when the invoice is paid rather than issued. However, input tax can only be recovered when the business pays the supplier.

• Annual Accounting

Businesses with an annual turnover not exceeding £1,350,000 (excluding VAT and excluding exempt supplies) may be permitted by HMRC to make an annual VAT Return. The VAT is paid by instalments during the year (based on the previous year’s VAT liability) with the balance being paid when the VAT Return is submitted.

• Flat Rate Scheme

Where a VAT-registered business has a taxable annual turnover not exceeding £150,000 (excluding VAT) and a total annual turnover (i.e. to include the VAT charged to the business, and the value of any exempt and other non-taxable income) not exceeding £230,000 the business may elect that VAT be charged at a flat rate on turnover rather than on every single transaction.

There is however not normally any relief for input VAT. The flat rate will depend on the type of business and HMRC publishes a table setting out the applicable rates for the different types of business such as hairdressers and estate agents. Since 1 April 2017, there are anti-avoidance rules requiring ‘limited cost traders’ who use a flat rate scheme to account for VAT at a rate of 16.5%.

Question 9

Corporation Tax is payable on:

Answer 9

· all income profits and

· chargeable gains

· of a body corporate

· that arise in its accounting period.

The sum of a company’s profits and gains is known as ‘TTP’ (taxable total profits chargeable to corporation tax).

Companies are assessed to corporation tax by reference to the financial year (1 April – 31 March). Note that because a company can choose its accounting period, it is often different to the financial year, which is the same for all companies.

The amount of TTP will determine the amount of corporation tax payable.

The rate of corporation tax for the tax year 2022/2023 was a flat rate of 19%. As of 1 April 2023, the main rate will increase to 25% for companies with profits greater than £250,000. A small profits rate of 19% will be introduced on 1 April 2023 for those companies whose profits do not exceed £50,000.

Question 10

Calculation of TTP - basic proforma

Answer 10

Chargeable gains

Sale proceeds

[Allowable Expenditure]

[Indexation Allowance]

[Capital/Trading Losses]

= Chargeable Gain

Income profits

Income receipts

[Deductible Expenditure]

[Capital Allowances]

[Trading Losses]

= Income Profits

Tax treatment of income for corporation tax purposes

You have already looked at the nature of capital and income receipts. Income and capital receipts are subject to different tax rules, so it is necessary to identify the nature of the receipts. This is the case even though companies pay corporation tax at the same rates on income and gains.

Remember the basic rule that income receipts and expenditure arise through everyday trading whereas capital receipts and expenditure arise from one-off transactions.

Question 11

What constitutes a company’s income?

Answer 11

The most common types of company income are:

• rental income;
• trading income;
• interest; and
• dividend income.

Question 12

Taxable income profits

Answer 12

To calculate the taxable income profits, you must aggregate all chargeable income receipts and deduct all tax-deductible expenditure.

• chargeable income receipts: Receipts of an income nature which arise from the business or trading activity (and which are not exempt receipts).
• tax deductible expenditure: Expenditure by a company that the company is permitted to deduct from its income receipts, thereby reducing its overall tax bill.

Deductible expenditure for income purposes

To be deductible for tax purposes the expenditure must:

• be ‘…wholly and exclusively’ incurred for the purposes of the trade – eg expenditure which is partially by way of gift;
• not be prohibited by statute – eg business entertainment expenditure (i.e. money spent by a company entertaining its clients) and provisions made in accounts for doubtful debts; and
• be of an income nature – eg rent, interest paid, wages, repairs.

Question 13

Adjustments for capital allowances

Answer 13

Capital expenditure is generally only deductible from capital receipts and not usually deductible to calculate income profits. In addition, depreciation (an accounting concept) is not an allowable deduction for tax purposes and therefore to allow businesses to spread the cost of certain capital assets over a period of time, ‘capital allowances’ are given as a deduction against income receipts.

Even though capital allowances relate to capital expenditure, the allowances are treated as a deduction for income purposes in calculating income profits. Capital allowances are available on qualifying items of expenditure.

Question 14

Qualifying expenditure includes expenditure incurred on plant and machinery.

Answer 14

There are other special capital allowances that apply to, for example, long life assets, research and development expenditure and certain costs of construction and renovation of commercial buildings but these are outside the scope of the module.

Capital allowances are available to individuals and partnerships carrying on a trade as well as to companies.

Question 15

Capital allowances on plant and machinery

Answer 15

Companies can deduct 18% of the value of plant and machinery (‘P&M’) from their income receipts each year on a ‘reducing balance’ basis. This means that when a company claims capital allowances in one year on P&M, the value of the P&M for tax purposes is reduced by 18%. This value is referred to as the ‘tax written down value’ or ‘TWDV’ of the P&M. When the company claims capital allowances in the following year, it will claim 18% of the TWDV of the P&M after it has been reduced by the previous year’s capital allowances claim.

Question 16

Annual Investment Allowance

Answer 16

Another type of capital allowance is the annual investment allowance (‘AIA’). This enables a company to deduct 100% of expenditure on P&M up to a specified amount. This is currently £1 million for any purchases before 31 March 2023.

The normal capital allowance of 18% can be applied to the balance of any expenditure above that amount. Therefore, if a company has spent more than £1 million in 2022 on P&M, the company is entitled to deduct from income profits the AIA of £1 million plus 18% of the balance of the expenditure. After the first year, the allowance reverts back to 18% per annum on a reducing balance basis.

Question 17

Capital Allowances: Super-deduction

Answer 17

A new type of capital allowance was introduced in the Finance Bill 2021 which allows companies to claim 130% first-year relief on expenditure incurred from 1 April 2021 until 31 March 2023 on qualifying plant and machinery.

The Super-deduction allowance will not apply to second-hand, used or leased assets. It will include expenditure on assets such as fire alarm systems, security systems, bathroom sanitaryware, carpets, computers equipment and servers, tractors, lorries and vans, ladders, drills and cranes, office desks and furniture, refrigeration units and electric vehicle charging points.

Unlike the AIA, there is no expenditure limit on the super-deduction allowance. We will not consider this further in the module.

Question 18

Assessment of tax, reliefs and exemptions for companies on disposal of capital assets

Answer 18

The same rules apply in relation to allowable expenditure for chargeable disposals by companies as for individuals (ie initial expenditure, subsequent expenditure (such as costs of defending title and enhancement expenditure) and costs of disposal can be deducted). But note the following differences between companies and individuals:

• There is no annual exemption for companies.
• Indexation allowance continues to be available for companies but is frozen up to 31 December 2017.

The Substantial Shareholding Exemption, or SSE, is a relief that can exempt from corporation tax the whole of a chargeable gain that arises when a company disposes of shares in a trading company (or the holding company of a trading group) provided certain conditions are met. The disposing company must have held at least 10% of the ordinary share capital of the

• company whose shares are being disposed of for at least 12 consecutive months in the last six years. This relief is not available for individual sellers BUT Companies cannot reduce the tax they pay on their chargeable gains by claiming Business Asset Disposal Relief or Investors’ Relief.

Question 19

Rollover relief for replacement of business assets (‘Rollover Relief’)

Answer 19

to defer tax that would otherwise be due in respect of a gain arising when an asset is disposed of. You were introduced to this relief earlier.

It will potentially be available in the following situations:

• where a company disposes of a qualifying business asset and it (or a company in its group) buys another qualifying asset (referred to as the ‘replacement asset’);
• where a sole trader or partnership disposes of a qualifying business asset and buys another qualifying asset;
• where an individual, other than a sole trader, owns a business asset, sells that asset and buys another qualifying asset and both assets are used by either:
• a company which is the individual’s personal company; or
• a partnership of which the individual is a partner.

Note that although the new asset is referred to as the ‘replacement asset’, it does not have to be the same type of asset as the asset which has been disposed of.

Question 20

General effect of the relief

Answer 20

The gain from a disposal of a qualifying asset is carried forward and ‘rolled’ into the acquisition cost of a qualifying replacement asset. The acquisition cost of the replacement asset is reduced by the amount of the gain being rolled over. Therefore, tax is postponed until the replacement asset is sold and no new qualifying replacement asset is purchased. It is possible to roll over gains indefinitely, provided sufficient qualifying replacement assets are bought within the time limits.

Question 21

Qualifying assets

Answer 21

Only certain types of the following assets attract Rollover Relief, including for example:

• land and buildings;
• goodwill;
• fixed plant and machinery;
• ships and hovercraft;
• aircraft, and
• Lloyd’s syndicate capacity.

Question 22

Timing of sale and purchase

Answer 22

The replacement asset must be purchased within 12 months before or three years after the sale of the old asset.

Question 23

Use of proceeds of sale

Answer 23

Rollover Relief can be restricted when not all of the sale proceeds of the original asset are used to acquire the new asset.

The amount by which the sale proceeds of the original asset exceed the cost of the replacement asset is deducted from the chargeable gain before Rollover Relief and only the remaining amount of the gain can be rolled over.

Essentially the gain to be rolled over is reduced by £1 for every £1 of the sale proceeds not reinvested.

Question 24

Dividend received and paid by companies

Answer 24

• Dividends paid to UK companies are subject to corporation tax unless the dividend falls within one of a number of exemptions. However, the exemptions are very broad and the general effect of the rules is that all dividends are exempt from corporation tax unless certain anti-avoidance provisions apply.
• Dividend income received by a company is therefore generally exempt from corporation tax and is therefore not included in that company’s TTP for tax purposes. A company pays a dividend out of profits that have already been taxed so the tax already paid satisfies the recipient company’s tax liability in respect of the dividend.
• For the same reason, the dividend is not tax deductible for the company paying it.

Question 25

‘Straddling’

Answer 25

Sometimes a company’s accounting year does not coincide with a financial year (‘FY’). This complicates the corporation tax calculation if the rates of corporation tax for the FYs are different.

Where this occurs, the TTP of the accounting period must be apportioned between FYs and the relevant proportions of TTP must be taxed at the applicable rates for the FYs.

Question 26

Loss Relief: Deductibility of trading losses

Answer 26

A trading loss occurs where tax deductible expenditure exceeds income receipts for a specific period. Trading losses can be set off against other taxable profits in, broadly, four different ways.

1. Current year profits

Trading losses can be set off against all other profits (ie income profits and chargeable gains) of the same accounting year. A claim must be made within two years after the end of the accounting period in which the loss arose.

2. Previous year profits

If trading losses cannot be used in whole or part against current profits, a company can carry back any remaining losses against taxable profits (income and chargeable gains) of the previous accounting period. The company must have been carrying on the same trade in both years to be able to carry the loss back to be set off against the previous year’s profits. A claim must be made within 2 years after the end of the accounting period in which the loss arose. If a company ceases trading, any trading loss in the final 12 months of trading can be carried back and set against any profits made in the three years prior to the start of the final 12 months.

3. Future trading profits

If there are still trading losses unused they are automatically carried forward and set against all the company’s taxable profits (income and chargeable gains) in the future.

The company must continue to trade the loss-making trade in the period in which the losses are used but use of the losses is not restricted to profits of the same trade.

4. Group relief

Where a group relief group exists, one company with a trading loss can surrender that loss to another profitable company in the group so that the surrendered loss can reduce or eliminate that company’s profits.

Question 27

Temporary extension of carry back of trading losses

Answer 27

As a temporary measure to assist those companies who have suffered losses due to the pandemic, the Government has temporarily extended the period over which the companies may carry back losses.

Trading losses incurred in accounting periods ending between 1 April 2020 and 31 March 2022 can be carried back as follows:

• one year without a cap (same as under current rules); and
• a further two years, but against more recent years first and subject to a cap of £2,000,000 of losses arising in accounting periods ending in the 1 April 2020 to 31 March 2021 period and a separate cap of £2,000,000 losses arising in accounting periods ending in the 1 April 2021 to 31 March 2022 period.

Question 28

Loss Relief: Deductibility of capital losses

Answer 28

Capital losses can only generally be set off against capital gains (also called chargeable gains). Capital losses can be set off against capital gains in the current year but they cannot generally be carried back to a previous year.

If there are still capital losses unused in the current year, they can be carried forward and set against any capital gains in future accounting periods.

The company may use carried forward capital losses against capital gains of up to the available Deductions Allowance in the relevant accounting period, provided that the Deductions Allowance has not already been used for the purposes of setting off carried forward trading losses against trading profits in that same period (see above for the current cap/allowance).

Where, in any accounting period, the company has unrelieved capital gains in excess of the available Deductions Allowance for that period, carried forward capital losses may be used to relieve a maximum of 50% of the unrelieved gains.

Capital losses can be carried forward indefinitely within the company that made them but in order to crystallise the loss, a claim must be made to HMRC within four years from the end of the accounting period in which the loss arose.

Question 29

Mechanics of corporation tax self-assessment

Answer 29

1. Procedure for companies with TTP of £1,500,000 or less

• Company estimates its tax liability and pays HMRC within 9 months and one day of the end of the accounting period.
• Company must file (electronically) a tax return within 12 months of the end of the accounting period to which it relates, together with its accounts. This will show how a company has calculated its tax liability.
• Unless HMRC examine or make enquiries into the tax return to establish whether or not the correct tax has been paid, the company’s tax computation will usually be regarded as finalised 12 months after the filing date for the tax return.
• Interest will accrue on any under or over-payments.

2. Procedure for companies with TTP of more than £1,500,000

Companies with TTP ofmore than £1.5m are required to pay their tax bills in four installments over the course of the relevant accounting period and the next one.

Question 30

Interest paid and received by companies

Answer 30

1. Deductibility of interest paid

Interest paid on business loans will generally be a deductible income expense ie a company can deduct the amount of the interest it has paid from its profits to reduce the TTP and thereby reduce the overall tax bill.

Where a company (or group of companies) has more than £2 million of net interest expense in the UK any year, the amount of interest a company may deduct is restricted to, broadly, a maximum amount equal to 30% of its income receipts. This is known as the corporate interest restriction, or CIR.

2. Obligation to withhold tax from certain interest payments

Tax is deducted at source from certain payments (eg income tax under the PAYE system). This is known as ‘withholding tax’, the person making the payment (in the case of PAYE, the employer) has an obligation to withhold the tax payable by the person receiving payment and pay it over to HMRC.

A company which pays interest may have an obligation to withhold tax from the payment, especially in an international context. However, a company which pays interest to another UK corporation tax paying company or a UK bank is allowed to make those payments without deducting tax from the payments (ie the company can make a gross payment of interest).

Question 31

Introduction to Close Companies

Answer 31

Companies which are ‘close’ companies (broadly, small companies, but see further below), are subject to special tax treatment. The close company regime is an example of anti-avoidance legislation.

The close company tax regime is an example of anti-avoidance legislation as it prevents or discourages taxpayers from exploiting some of the tax benefits of incorporation.

There are various special tax rules applicable to close companies. The most important of these are as contained in this element.

Definitions

A company will be a close company if it is under the control of:

• five or fewer participators; or
• any number of participators who are also directors.

A ‘Participator’ is a person having a share or interest in capital or income of the company, for example, shareholders and some creditors.

‘Control’ means the ability to exercise control over the company’s affairs, normally by voting rights, or the possession of or entitlement to:

• issued share capital allowing the greater part (ie more than 50%) of income of the company if distributed; or
• the greater part of assets of the company on winding up.

However, there are some exclusions from the definition, eg a company will not be a close company if:

• its shares are quoted on a recognised stock exchange; or
• it is controlled by one or more non-close companies, and it could only be a close company by treating a non-close company as one of the five or fewer participators having control.

Therefore, for example, a company which is a wholly-owned subsidiary of a non-close company will not be subject to the close company tax regime.

In assessing a person’s ‘control’, rights and entitlements of that person’s ‘nominees’, ‘associates’ and companies controlled by the individual need to be considered.

‘Associate’ means any close relative, ie spouse, parent (or remoter forebear), child (or remoter issue), brother or sister.

‘Nominee’ means a person owning property on behalf of another.

Question 32

Close companies: Taxation effect - Loans to Participators

Answer 32

1. ‘Loans’: All advances of credit are caught, except for:

• a loan in the form of credit given by a company in respect of goods or services normally supplied by the company in the course of business where the duration of the credit does not exceed six months or the company’s normal limit; or
• a loan made in the ordinary course of a company’s business which includes money lending; or
• a loan to a borrower which, together with other outstanding loans made by the company to that borrower, does not exceed £15,000 in aggregate and the borrower works full time for the company and does not have a ‘material interest’ in the close company.

‘Material Interest’:This means indirect control of more than 5% of the ordinary share capital of the company or an entitlement on winding up of more than 5% of the assets available.

The tax effect for the company

The company must pay corporation tax to HMRC on the amount of the loan, calculated at the rate of income tax payable on dividends by higher rate taxpayers. The tax must be paid within nine months and one day after the end of the accounting period in which the loan is made.

The company may claim a refund of the tax paid if the loan is repaid, satisfied, written off or waived.

The tax effect for the recipient participator

If the loan is written off or waived, the participator is deemed, for income tax purposes, to receive a dividend equal to the amount of the loan written off/waived. There is no tax effect for the participator if he pays back the loan in full.

Question 33

Close companies: Taxation effect – Distributions and IHT Implications

Answer 33

2. Distributions

The term ‘distribution’ has an extended meaning for close companies.

It includes living accommodation and other benefits in kind provided (ie distributed) to participators (but not where such benefits are provided by reason of employment).

3. Inheritance Tax Implications

As only individuals pay IHT, it is possible to form a company and make a transfer through that company. There is anti-avoidance legislation, which means that a transfer of value by a close company results in the value of the gift being apportioned between its shareholders.

Question 34

Close companies: Taxation effect - Transactions in Securities rules

Answer 34

4. Transactions in Securities rules

The transactions in securities rules may apply, broadly, to a transaction involving a close company, where the transaction gives any person a tax advantage by changing a receipt which would have been treated as income for tax purposes, into a capital receipt. For example, where a close company has substantial distributable profits and instead of being passed to shareholders as a dividend (taxed as income), the close company is wound up and the profits passed to shareholders as a (capital) payment on a winding up, the transactions in securities rules may apply. Where they apply, the rules operate to counteract the tax advantage.

When acting on a transaction which may fall within the transactions in securities rules, it may be advisable to apply to HMRC for advance clearance. Clearance would state that HMRC is satisfied that the provisions do not apply to the transaction. Your client’s specialist tax advisers will be responsible for assessing whether this would be advisable on a particular transaction.