Company Ownership Flashcards
(126 cards)
1
Q
Shareholders appoint __________who are responsible for the __________of the company on behalf of the shareholders.
A
Shareholders appoint directors who are responsible for the control of the company on behalf of the shareholders.
2
Q
Limited companies can be public or private, and shares in a public limited company can be purchased and sold without the permission of _________
A
other shareholders.
3
Q
Limited liability __________the personal wealth of shareholders.
A
protects
4
Q
A company’s profit is calculated annually, and a _______is declared from this profit which is paid to each shareholder in proportion to the number of _______they own.
A
A company’s profit is calculated annually, and a dividend is declared from this profit which is paid to each shareholder in proportion to the number of shares they own.
5
Q
A business entity where partners’ liabilities are limited to the amount of money they have invested in the business.
A
Limited Liability Partnership:
6
Q
LLPs have a separate legal identity from the owners, and they are taxed as .
A
partnerships
7
Q
LLPs offer ______liability protection to partners and allow flexibility in management and profit-sharing.
A
limited
8
Q
Contrast the different types of liability which are characteristic of the following forms
of business entity:
sole trader
partnership
limited company
limited liability partnership
A
Chapter 2 Solutions
Solution 2.1
A sole trader has unlimited liability. The whole of the owner’s personal wealth is at
risk if the business runs into debt and is sued.
In a partnership there is unlimited liability. Partners are jointly and severally liable for
the debts of the business. Their entire personal wealth may be at stake if the partnership
is sued successfully.
A limited company is owned by shareholders. Shareholders’ liability is limited to the
fully-paid value of the shares they own. Creditors cannot claim payment from the
shareholders’ personal wealth.
In a limited liability partnership, each member’s liability is limited to the amount that he
or she put into the business.
9
Q
Question 2.2
Draw up a table to compare a partnership, a limited liability partnership and a limited
company with respect to:
main source of finance
legal identity
liability
documentation
disclosure
tax.
A
Solution 2.2
Partnership LLP Limited company
Source of finance Partners Members Shareholders
Legal identity Not separate Separate Separate
Liability Unlimited Limited Limited
Documentation None Partnership
agreement
recommended; must
be registered at
Companies House
and granted a
certificate of
incorporation.
Memorandum and
Articles of
Association; must
be registered at
Companies House
and granted a
certificate of
incorporation.
Disclosure None, though the
accounts will be
needed by HMRC
to calculate each
partner’s tax
liability.
Rules on disclosure;
must produce
audited accounts if
above a certain size.
HMRC needs
accounts to
calculate tax
liability.
Rules on disclosure;
all companies above
a certain size must
produce audited
accounts.
Tax Partners pay income
tax.
Members pay
income tax.
Companies pay
corporation tax
10
Q
type of company that is privately owned by a group of individuals.
A
Private Limited Company:
11
Q
The company’s shares are not available for public purchase or sale for a
A
Private Limited Company:
12
Q
The number of shareholders is limited to 50.
A
Private Limited Company:
13
Q
The liability of the shareholders is limited to the amount they have __________ in the company.
A
invested
14
Q
A private limited company is not required to file its __________ with the Registrar of Companies.
A
financial statements
15
Q
is a type of company that offers its shares to the public for purchase or sale.
A
A public limited company
16
Q
The minimum issued share capital for a public limited company is in Zambia. is
A
K50, 000
17
Q
The company’s name must end with the words
A
“public limited company” or the abbreviation “PLC” or “plc”.
18
Q
The number of shareholders is not .
A
limited
19
Q
The liability of the shareholders is limited to the
A
amount they have invested in the company.
20
Q
A public limited company must be correctly registered with thex
A
A public limited company must be correctly registered with the Registrar of Companies at Companies House.
21
Q
A__________ company must produce audited accounts.
A
Public limited companies
22
Q
Each issued share must be paid up to _______of its par value plus the whole of any premium on it.
A
at least a quarter
23
Q
___________companies are a type of limited company, where shares cannot be offered to the public.
A
Private Limited
24
Q
The name of a private limited company must end with the word
A
“limited” or the abbreviation “LTD” or “ltd”.
25
Private limited companies are more typically small companies with a ________range of shareholders, often being _________ businesses.
Private limited companies are more typically small companies with a narrow range of shareholders, often being "family run" businesses.
26
Private limited companies are required to produce annual accounts, but they are not required to make
them publicly available.
27
Why is it easier for a limited liability company to raise capital than it is for a large
partnership?
People may be reluctant to become involved as a part owner of a partnership since they
risk their entire personal wealth. With limited liability people should be much more
willing to provide capital.
PLCs have to comply with certain rules regarding the standards of accounts, which may
give investors more confidence in the company.
Where shares are quoted on an exchange, their value is easily determined. If the company
has to raise finance by selling shares, the price can be quickly negotiated.
A partnership
may have difficulties determining the “value” of a part ownership
28
Advantages of limited companies:
-Easier to raise capital: Limited liability makes it easier for companies to raise capital by allowing large numbers of people to invest small amounts of money without requiring day-to-day control over the company. This enables investors to diversify their exposure to sectors and the risk of failure.
-Separation of ownership and control: The separation of ownership and management allows share ownership to change without interfering with the operation of the business. It also allows the firm to hire professional managers.
29
Disadvantages of limited companies: To the creditors:
-To the creditors: Once the company's assets have been exhausted, trade creditors have no way of ensuring payment following a wind-up. Similarly, customers have no way of ensuring that they receive goods and services for which they have pre-paid.
30
Disadvantages of limited companies: To the company:
To the company: Limited liability allows people to invest in shares without taking an active interest in the long-term needs of the company. This may lead to short-termism and a lack of interest in the long-term health of the company.
31
Disadvantages of limited companies: To the shareholders:
-To the shareholders: The managers of a company may have aims that are not in the best interests of the shareholders (agency problem).
Information asymmetries may also exist, where different stakeholders have different information about the value of a real or financial asset.
32
__________ has been crucial in the development of large, efficient industrial enterprises. However, it also has some drawbacks, particularly in terms of the risk it poses to _______and _______. Additionally, it can lead to ______ and may not always align the interests of shareholders and managers. ________ standards can help address some of these issues.
Limited liability has been crucial in the development of large, efficient industrial enterprises. However, it also has some drawbacks, particularly in terms of the risk it poses to creditors and customers. Additionally, it can lead to short-termism and may not always align the interests of shareholders and managers. Proper accounting standards can help address some of these issues.
33
Question 2.4
If you were starting up a new business with a friend, what factors would you consider
when deciding whether to set up as a partnership or a company?
Solution 2.4
The main factors to consider when deciding on the type of business organisation to set up
with your friend are:
the need for finance and the amount of finance you are able to contribute - the more you
need and the less you have, the more likely it is that you will consider setting up a company.
the ease of raising finance in the future - the greater your plans to expand, the greater the tendency to set up a company.
liability for debts - the greater the possibility of running into debt, the more likely you
are to consider setting up a company.
ease of setting up - the quicker and cheaper you want the set up to be, the more likely
you are to set up a partnership.
disclosure - the more reluctant you are to disclose information about the business, the
more likely you are to set up a partnership.
control of the business - the greater the amount of control you want to retain, the more
likely you are to set up a partnership. However, you could set up a private limited
company with just a few (even two) shareholders if you wish to retain tight control.
roles and responsibilities - the firmer you wish the roles and responsibilities to be defined, the more likely you are to set up a company. However, you could have a firm
partnership agreement. This is linked to the trust you have in your friend.
the type of business - the greater the need to display commitment in order to gain trust,
eg accountants, solicitors, the greater the tendency to set up as a partnership.
NB. The LLP might be a good compromise!
34
All organizations require _______to finance premises, equipment, and operations.
capital
35
Medium-term finance has a term of over ____ but less than _______.
Medium-term finance has a term of over one year but less than about five years.Medium-term finance has a term of over one year but less than about five years.
36
Short-term finance has a term of less than_____
one year
37
Four forms of medium-term finance are ;
hire purchase, credit sale, leasing, and bank loans.
38
Hire purchase agreements are used for both _____and _______transactions.
Hire purchase agreements are used for both consumer and commercial transactions.
39
It is an agreement to hire goods for a _____ and make ____________, then to buy the goods at the end of the rental period.
It is an agreement to hire goods for a period and make regular rental payments, then to buy the goods at the end of the rental period.
40
Legal ownership passes to the buyer only when the final ____.
Legal ownership passes to the buyer only when the final payment is made.
41
The _______is usually made to buy the good.
The last regular payment is usually made to buy the good.
42
(Hire purchase)Payments are partly for the ______ and partly ______.
Payments are partly for the good and partly interest.
43
If the buyer fails to make payments, the seller?
If the buyer fails to make payments, the seller can take back the goods.
44
Credit sale
Credit sales are similar to hire purchase agreements, but legal ownership passes to the buyer at
the outset.
45
Credit sale is
It is a normal sale of a good with an agreement for payment in regular installments over a set period.
46
(credit sale) Payments are partly ____and partly _____for the good.
Payments are partly interest and partly payment for the good.
47
credit sale can the seller reclaim the goods if the buyer defaults,
The seller cannot reclaim the goods even if the buyer defaults, but they can sue for payment.
48
Credit sales are less popular with sellers dealing with customers of dubious ______.
Credit sales are less popular with sellers dealing with customers of dubious creditworthiness.
49
Question 2.5
Compare and contrast a credit sale agreement with a hire purchase agreement.
Solution 2.5
Ownership of asset - Under a hire purchase agreement, ownership of the asset does
not pass to the buyer until the last payment is made. Under a credit sale agreement the
ownership passes immediately.
Structure of payments - Both involve a series of (usually fixed) payments over a
period of typically up to ten years.
Event of default - Under a hire purchase agreement the owner can reclaim the asset.
Under a credit sale, the recipient of the payments must sue to reclaim the outstanding
amounts.
50
x________is an arrangement used by companies to obtain the use of machines, property, and vehicles.
Leasing is an arrangement used by companies to obtain the use of machines, property, and vehicles.
51
________ of the asset does not change hands in a lease agreement, and the lessee simply ________the asset from the lessor.
Legal ownership of the asset does not change hands in a lease agreement, and the lessee simply rents the asset from the lessor.
52
A lease agreement may include an option to ______the asset at the end of the lease period, but the payment will reflect the remaining value of the asset, and the lessee is not obligated to buy the asset.
A lease agreement may include an option to buy the asset at the end of the lease period, but the payment will reflect the remaining value of the asset, and the lessee is not obligated to buy the asset.
53
There are two types of leases: ________ and _______. The difference between them depends on the length of the lease in relation to the expected economic life of the asset.
There are two types of leases: operating leases and finance leases. The difference between them depends on the length of the lease in relation to the expected economic life of the asset.
54
In an operating lease, the owner of the asset __________ and the lease is for a period substantially shorter than ____________>
In an operating lease, the owner of the asset retains most of the risks associated with owning the asset, and the lease is for a period substantially shorter than the likely life of the asset.
55
In a finance lease, the lessee _______, and the lease is for a period similar to the likely life of the asset. In effect, the lessee is buying the asset outright but financing the purchase by paying rent rather than a lump sum upfront.
In a finance lease, the lessee takes on most of the risks associated with owning the asset, and the lease is for a period similar to the likely life of the asset. In effect, the lessee is buying the asset outright but financing the purchase by paying rent rather than a lump sum upfront.
56
The present value of the payments under a finance lease agreement is shown in the lessee's balance sheet twice: as ________ and as a corresponding _______.
The present value of the payments under a finance lease agreement is shown in the lessee's balance sheet twice: as an asset and as a corresponding liability.
57
The classification of a lease as an operating lease or finance lease depends _____
on the lease term and the risks associated with owning the asset.
58
give example to illustrate the difference between an operating lease and a finance lease.
Example
The owner of a gold mine with an expected working life of 15 years leases the mine to a
mining company for 3 years. In this case the owner of the gold mine still experiences
the joy of seeing gold prices rise, and the misery of seeing them fall, because he has an
asset which is heavily dependent upon the price of gold. This lease would be classified
as an “operating lease”.
If, on the other hand, he had leased the mine for 14½ years, he would have effectively
sold it. The lease is being used only as a finance arrangement. The owner might be as
interested in whether Norway win the Eurovision Song Contest again as in what
happens to the price of gold. Such a lease is known as a “finance lease”.
59
what is a bank loan?
A bank loan is a form of medium-term borrowing from a bank where the full amount of the loan is paid into the borrower's current account, and the borrower agrees to make interest payments and capital repayments on the full amount of the loan.
60
Bank loans are usually secured on the borrower's _______, although________loans are sometimes granted.
Bank loans are usually secured on the borrower's assets using a floating charge, although unsecured loans are sometimes granted.
61
Bank loans can be used to buy non-current assets such as
machinery and vehicles.
62
The interest rate on a bank loan is usually ______, but _____-rate bank loans also exist.
The interest rate on a bank loan is usually variable, but fixed-rate bank loans also exist.
63
The interest rate may be set at a margin above the bank's own base rate or as a margin over a benchmark interest rate such as _______.
LIBOR
64
Loan facilities have expanded over the last decade, with options such as loans that X______
Loan facilities have expanded over the last decade, with options such as loans that allow the borrower to take out the loan in instalments with prior notice to the bank.
65
LIBOR exapmle
A company arranges a £2,000,000 bank loan to buy a piece of machinery. The interest
rate is set as being 3% above 3-month LIBOR. At outset, 3-month LIBOR is 6.2% (it is
customary to quote as an annual rate of interest), so the company pays interest at a rate
of 9.2% for the first 3 months. After the first 3 months, 3-month LIBOR is 6.9% pa, so
the company pays 9.9% for the next 3 months, and so on.
66
Question 2.6
Give some examples of situations where a syndicated loan might be considered
Solution 2.6
In 2010, and again subsequently, the European Union and the International
Monetary Fund agreed a bailout package for Greece, involving loans of
€240 billion in total.
Banks lending to the companies that built the Millennium Dome would have
loaned on a syndicated basis.
The venues and the infrastructure for the 2012 London Olympics were funded
by the departure for Culture, Media and Sport, the Greater London Authority
and the National Lottery
67
short-term company finance Bank overdrafts
Bank overdrafts are a form of short-term borrowing from a bank that allows a borrower to withdraw money from their account beyond its balance, up to an agreed limit.
68
Bank overdrafts The borrower pays interest only on the ________ and no explicit capital repayments are made.
overdrawn amount,
69
why is bank over drafts deemed risky for long term borrowing
Overdraft facilities usually need to be renegotiated annually, and the bank can demand immediate repayment with no notice, making it risky for long-term borrowing purposes.
70
define Trade credit
Trade credit is an agreement between a company and its suppliers to pay for goods or services after they have been supplied.
71
what is Factoring
Factoring is an alternative way for suppliers to finance the trade credit they have to give.
72
There are two types of factoring:
non-recourse factoring and recourse factoring (or invoice discounting)
73
Non-recourse factoring involves
Non-recourse factoring involves the supplier selling their trade debts to a factor to obtain cash payment of accounts before their due date, with the factor taking responsibility for credit analysis, payment collection, and credit losses.
74
Recourse factoring involves
the factor giving the supplier money upfront, but the supplier is still responsible for collecting their debts.
75
When a company supplies goods or services to another company on credit terms, it can draw up a formal bill and ask the other company to sign it.
The bill is known as a
trade bill or an acceptance
76
The purpose of getting the other company to accept the bill is that the supplier can subsequently _______the bill if it needs cash quickly.
The purpose of getting the other company to accept the bill is that the supplier can subsequently sell the bill if it needs cash quickly.
77
Most trade bills have to be _______ by an investment bank before they can be bought by a discount house or a bank.
Most trade bills have to be guaranteed by an investment bank before they can be bought by a discount house or a bank.
78
Bills of exchange are known as two-name papers because ?
they carry both the name of the company which owes the money and the name of the accepting bank.
79
Commercial Paper:
Commercial paper is a form of short-term borrowing by large companies.
Issuing commercial paper is an alternative to overdrafts or short-term bank loans
80
Commercial Paper: Payment is made to whoever presents
the piece of paper at the end of the term.
81
Question 2.7
Which is likely to be more expensive: a bank loan or a bank overdraft?
Solution 2.7
A bank overdraft will be more expensive. The reasons include:
Overdrafts are more flexible for the borrower. This means that they are less
predictable for the lender.
Loans are normally secured on assets of the company. Overdrafts are sometimes
unsecured and therefore more risky for the lender. (More risk means higher
return expected.)
82
Question 2.8
(i) What are the advantages and disadvantages of hire purchase agreements and
credit sale agreements from the point of view of the supplier?
(ii) State the main distinction between an operating lease and a finance lease.
(iii) State the main distinction between a bank loan and a loan facility.
(iv) State the main distinction between a loan facility and an overdraft.
(v) State the main distinction between a credit sale agreement and trade credit.
(vi) What are the advantages and disadvantages of invoice discounting and nonrecourse factoring from the point of view of the supplier?
(vii) Describe how a company raises finance using:
(a) bills of exchange
(b) sterling commercial paper
and indicate the most important differences between these two financial
instruments
Solution 2.8
(i) Hire purchase and credit sale agreements
Hire purchase
Advantage to supplier: the supplier retains ownership of the goods until the end
of the term of the agreement and can reclaim them if the buyer does not keep up
the repayments. Seller receives interest on top of the price of the goods.
Disadvantage to supplier: few disadvantages (although not as good as getting the
cash up-front).
Credit sale agreement
advantage to supplier: seller receives interest in addition to the price of the
goods.
disadvantage to suppliers: legal ownership of the goods passes to the buyer at
the start of the agreement. If the buyer defaults on the repayments, the seller has
to sue the buyer through the courts.
(ii) Operating and finance leases
Operating lease
The owner of the asset retains most of the risks associated with ownership of the asset.
The term of the lease will be substantially shorter than the expected useful life of the asset.
Finance lease
The lessee takes on most of the risks and rewards of ownership. The term of the lease will
be close to the expected useful life of the asset.Page 36 CT2-02: Company ownership
© IFE: 2016 Examinations The Actuarial Education Company
(iii) Bank loan and loan facility
Bank loan
Here, a fixed sum is lent to the borrower on a fixed date for a specified term.
Loan facility
A sum is made available to the borrower. The borrower may draw the sum in instalments,
giving the bank a few days’ notice of each instalment. In addition, there may be flexible
repayment arrangements. Interest is only charged on the amount outstanding.
(iv) Loan facility and overdraft
Loan facility
A sum of money is available for borrowing. This sum can be drawn in instalments and
added to the borrower’s bank account. The bank will need a few days’ notice before each
instalment is made. There may be flexible repayment terms.
Overdraft
The borrower is granted a facility to draw money out of a current account so that its
balance becomes negative, subject to an agreed maximum limit. The borrower does not
have to give any notice to be able to use the overdraft. There are no set repayment terms.
However, the bank has the option to demand immediate repayment of the overdraft at any
time with no notice.
(v) Credit sale and trade credit
Credit sale
This will be repaid by regular instalments over a period of time. The instalments will
include an element of interest.
Trade credit
This means that a company can pay its supplier for goods and services after they have
been received. Typically, business customers will settle their bills 30 to 60 days after they
have been invoiced. The bills are then settled in full, in one payment. No explicit interest
is charged, although suppliers may give discounts for “cash on delivery”.CT2-02: Company ownership Page 37
The Actuarial Education Company © IFE: 2016 Examinations
(vi) Invoice discounting and non-recourse factoring
Invoice discounting (recourse factoring)
advantage to supplier: supplier receives a certain proportion (say 85%) of the
amount it bills immediately from the factor.
disadvantage to supplier: the supplier still has to provide its own credit
administration and collect its debts. It bears the credit risk. In addition it has to
pay interest to the factor, based on the amount of time between the date the
advance was made and the date that payment was received from the customer.
Non-recourse factoring
advantage to supplier: supplier receives a certain proportion (say 85%) of the
amount it bills immediately from the factor. In addition the factor gives a full
administration service and will take on the credit risk associated with the
invoices.
disadvantage to supplier: the main disadvantage is that the factor wants only to
get paid as soon as possible. It has no particular interest in maintaining good
relationships with the supplier’s customers. It may therefore apply pressure to
such an extent that the supplier loses goodwill and subsequently custom
(although this may not be such a disadvantage if the customers were bad
payers!).Page 38 CT2-02: Company ownership
© IFE: 2016 Examinations The Actuarial Education Company
(vii) Bills of exchange and sterling paper
Bills of exchange
A company can issue a bill to one of its customers. If the customer accepts the bill, and it
is guaranteed by an investment bank, the original company can sell the bill to a discount
house for cash, rather than having to wait for the acceptor to pay up. Bills of exchange
therefore provide short-term cash to companies.
Commercial paper
A company can issue commercial paper directly to investors. The company must meet
certain requirements, such as being listed on the London Stock Exchange. The term of the
commercial paper must be between one week and one year.
Both of these forms of borrowing are short-term negotiable financial instruments. The
main difference between them is that bills of exchange must be guaranteed by an
investment bank, and are therefore two-name instruments, whereas commercial paper is
not guaranteed by a bank, and is therefore a single-name instrument. Bills of exchange
can be issued by any company, whereas commercial paper can only be issued by large
quoted companies that meet certain requirements.
83
Personal taxation is levied on
an individual's financial resources, including income (earned or unearned), profit from operating as a sole trader or partner, inherited wealth, investment gains, and value of assets held.
84
_____________ is a main source of tax revenue for governments, with employed and self-employed individuals paying it. Additionally, social security contributions are levied on earnings.
Income tax
85
Governments may introduce taxes on capital gains, ____, and _______, with the Council Tax being a tax based on the value of property in the UK.
wealthy and inheritance
86
Taxation in many countries is limited to cash flows, as it is
easier to tax income than wealth due to the latter being tied up in large, indivisible units. Tax liabilities may also be assessed in arrears, with exemptions for some basic levels of income or wealth.
87
Governments aim to tax revenue flows only once in the hands of _______, but revenue may be taxed twice if taxes are levied on wealth or the value of specific assets.
Governments aim to tax revenue flows only once in the hands of recipients, but revenue may be taxed twice if taxes are levied on wealth or the value of specific assets.
88
Tax-free income in the UK includes
most profits from gambling, most forms of social security benefit, and income from certain types of investment.
89
Tax relief may be available on certain forms of expenditure,
such as contributions to an approved pension scheme and charitable gifts, reducing taxable income.
90
Tax rates
91
How is taxable income calculated?
Solution 3.1
Taxable income is calculated as follows:
income earned
plus income in kind
plus gross investment income
less tax-free income
less tax-free expenditure
less allowance
92
Question 3.2
Assume that the personal allowance is £5,000, and that the marginal tax rates are 20%
for the first £40,000, and 40% for taxable income above this. Assuming there are no
adjustments to total income, how much tax will a single person earning £50,000 pay?
What proportion of total income is paid in tax?
Solution 3.2
There is a personal allowance of £5,000, so the person is only taxed on £45,000 of
income.
Tax rates Tax bands Tax due
Taxed @ 20% £40,000 £8,000
Taxed @ 40% £5,000 £2,000
Total £10,000
Total tax paid is 20% of total income. This is known as the average rate of tax.
93
The starting point for a company’s tax assessment is “profit on ordinary activities before taxation”, which is the accounting profit calculated as:
Sales revenue - Expenses = Operating profit + Non-trading income (interest, dividends, capital gains) = Profit before tax and interest - Interest paid = Profit before tax.
94
Companies are liable to corporate income tax on their taxable profits, which usually include both
income (less allowable expenses) and capital gains.
95
After tax has been deducted, the company distributes some of the after-tax profits to ______and______
the shareholders in the form of a dividend and retains the rest in the business as retained profit.
96
Taxable profit is calculated by
adjusting accounting profit before tax, adding back any business expenses or potential expenditure shown in the accounts that are not allowable for tax, adding back any charge for depreciation, and instead subtracting the “capital allowances”, and deducting any special reliefs.
97
The rates of tax
In the UK, for the tax year 2015-16, the standard rate of corporation tax is
20%.
98
Corporation tax rates around the world vary considerably, and a corporation tax rate of _______is often used as a proxy for the true rate of a company’s corporation tax.
f 30%
99
Uses of the corporation tax system
Some countries give relief to shareholders to ensure that dividends are not subject to both _____and _______ income tax.
Uses of the corporation tax system
Some countries give relief to shareholders to ensure that dividends are not subject to both personal and corporate income tax.
100
Dividend income is known as
franked income, and most governments give at least some credit to the shareholder for the tax that has already been paid.
101
Governments sometimes seek to incentivize companies to retain and reinvest earnings
by levying higher taxes on dividends than on “retained” profits, or by allowing tax relief for new investment such as “capital allowances” or accelerated depreciation.
102
A particular example of this relates to pension provision, where the government may seek to encourage private and institutional pension arrangements by offering tax reliefs on contributions and investment earnings within the pension scheme.
on contributions and investment earnings within the pension scheme.
103
What are the three main adjustments that have to be made to accounting profit to arrive
at taxable profit?
Solution 3.3
The three main adjustments are:
adding back on any business expenses or potential expenditure that are not
allowable
adding back depreciation and deducting the capital allowance
deducting any special reliefs, eg research and development.
104
Question 3.4
How can the government use the corporation tax system to encourage or discourage a
particular activity
Solution 3.4
The government can:
use a lower rate of tax on retained profit than on distributed profit to encourage
investment
allow pension contributions to be treated as an expense and grant tax relief to
investment earnings within the scheme to encourage the setting up of pension
schemes.
105
Individuals and companies are both subject to capital gains tax when they make a profit on
the sale of an asset.
106
Chargeable gains are usually calculated based on the tax year in which the gain is
realized.
107
Calculating chargeable gains involves
determining the sale price and purchase cost of the asset.
108
A chargeable gain is defined as
the sale price minus the purchase cost of the asset.
109
The sale price can be reduced to _______ and the purchase cost can be increased by any costs associated with the purchase or any expenses made to____________
The sale price can be reduced to reflect any costs associated with the sale, and the purchase cost can be increased by any costs associated with the purchase or any expenses made to enhance the value of the asset.
110
Some assets are exempt from capital gains tax,
such as private motor cars, a main private residence, and small tangible moveable assets worth less than £6,000.
111
Indexation allowance is used to
remove the inflationary element of any gain.
Some countries allow for indexation allowance to remove the effect of inflation on gains, or to encourage individuals to retain assets.
112
Capital losses can be offset against
capital gains, but not against any other form of taxation.
113
If the chargeable gain calculation results in a negative number, it is considered a
capital loss.
114
Capital losses can be used to
offset against capital gains and carried forward to future years.
115
Capital losses cannot be used to offset against
any other form of taxation, and the rules for offsetting capital losses do not apply if the loss is only caused by indexation allowance.
116
Question 3.5
Assume the same tax system as given in the above example. Mrs Y has £1,000 of the
basic-rate tax band left unused. She makes a chargeable gain of £15,000. How much
capital gains tax does she pay
Solution 3.5
Mrs Y’s chargeable gain is in excess of the annual allowance of £11,100. She will
therefore pay capital gains tax on £15,000 – £11,100 = £3,900.
She has £1,000 of the basic rate allowance left so:
Tax rates Amount of gain Tax due
Taxed @ 18% £1,000 £180
Taxed @ 28% £2,900 £812
Total £992
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Question 3.6
Explain which of the following items would be subject to capital gains tax for Mr X, a
resident UK taxpayer?
1. The sale of Mr X’s house.
2. The sale of a house that Mr X bought for his long-lost aunt to live in.
3. The sale of Mr X’s car (a vintage Rolls Royce).
4. The sale of Mr X’s collection of antique silver snuff boxes (valued at £18,000).
5. The transfer of Mr X’s holiday cottage to his wife.
Solution 3.6
The following items will be liable for CGT:
2. because the house was not Mr X’s main residence
4. no exemption for snuff boxes! (because the collection is valued at more than
£6,000).
The following items will not be liable for CGT:
1. assuming it is Mr X’s principal UK residence
3. because CGT does not apply to private motor cars
5. because it is a transaction between a husband and wife.
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Question 3.7
Are the following true or false?
(i) Chargeable gains made by individuals are taxed at their marginal rate.
(ii) Capital losses can be offset against the profit made from normal trading activities.
(iii) A husband and wife have an effective capital gains allowance that is double that
of an individual.
Solution 3.7
(i) False. The two rates are 18% and 28%.
(ii) False. Capital losses can only be offset against capital gains: they cannot be
offset against any other tax.
(iii) True. Transactions between a husband and wife do not normally attract capital
gains tax; therefore spouses can transfer assets between themselves to “double
up” their allowance.
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Stamp duty
on contract documents is a tax levied on the value of certain documents such as property contracts. For example, when an individual buys a house, they must pay stamp duty tax based on the value of the house.
120
Inheritance taxes
Inheritance taxes are taxes levied on the transfer of wealth from one generation to another. These taxes vary by country and are generally based on the value of the inherited property.
121
Property taxes
are taxes levied on real estate property, such as land or buildings. These taxes are usually based on the value of the property and are paid by the owner of the property.
122
Sales taxes, such as VAT in the UK or a sales tax in the US, are taxes
collected at the point of final sale to the consumer. Value Added Tax (VAT) is collected at each stage of the production process according to the value added at each stage. Certain classes of "essential" expenditure, such as basic foodstuffs, may be exempted from sales taxes.
123
Customs duties
are taxes on imported goods, which vary by country and can be based on the value, weight, size, or emissions of the goods.
124
Excise duties
are taxes levied on goods produced and sold within the country, such as duties on petrol, beer, and cigarettes. These taxes may be designed to encourage certain patterns of consumer expenditure or to raise revenues for particular categories of government expenditure.
125
Double taxation relief (DTR) is a system that allows
companies and individuals with overseas income or capital gains to offset tax paid overseas against their liability to domestic tax on that income or capital gains. The maximum offset is the rate of tax that would have been paid locally, and double tax relief cannot result in tax being reclaimed from the tax authorities.
126
Explain what is meant by “double taxation relief”.
Solution 3.8
Allows overseas tax paid in countries for which double taxation agreements
exist to be offset against liability to domestic tax.
Applies to individuals and companies.
Applies to income and capital gains.
The credit is equal to the lower of foreign tax paid and the UK tax due.
