Corporation tax - Basis of charge

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Overview

Corporation tax is central to UK tax law and plays a key role in the SQE1 FLK1 exam. This guide explores the diverse aspects of corporation tax, including charge calculations, relief strategies, and their application. A solid understanding of these elements is vital for exam success and advising corporate clients on tax matters.

Basis of Charge for Corporation Tax

Scope and Application

Corporation tax targets UK-resident companies and foreign entities with a permanent UK presence, covering:

  1. Income profits
  2. Chargeable gains
  3. Loan relationship profits
  4. Derivative contract profits
  5. Profits from intangible assets

This tax encompasses more than just trading income, addressing a wide range of corporate financial activities.

Residence and Permanent Establishment

A company is UK-resident if incorporated or if its central management is in the UK. The permanent establishment for foreign companies includes:

  • A fixed business location
  • An agent authorized to make contracts
  • Long-term construction projects

These criteria determine if a non-UK company is subject to UK corporation tax.

Calculating Corporation Tax: A Step-by-Step Guide

1. Determining Taxable Profits

a. Income Profits

This includes all company revenue, such as:

  • Trading Profits: From primary business activities.
  • Property Income: From real estate.
  • Investment Income: Including interest and dividends.

b. Allowable Expenses

Taxable profits require the deduction of expenses incurred "wholly and exclusively" for business purposes, such as:

  • Salaries and wages
  • Rent and rates
  • Utilities
  • Raw materials and supplies
  • Advertising and marketing
  • Professional fees

2. Capital Gains: Recognizing Profits from Asset Sales

a. Determining Chargeable Gains

These gains occur when an asset's sale price exceeds its purchase price. Deductions include brokerage, legal, and advertising costs.

b. Capital Gains Reliefs

Reliefs help reduce tax on chargeable gains, such as:

  • Rollover Relief: Defers capital gains tax by reinvesting in qualifying assets.
  • Business Asset Disposal Relief (BADR): Potentially lowers the tax rate to 10% for assets held over two years.

3. Strategic Use of Reliefs to Lower Tax

Effective use of reliefs is essential to tax planning:

a. Carry-Back and Carry-Forward Reliefs

  • Carry-back Relief: Offsets current losses against previous profits.
  • Carry-forward Relief: Offsets losses against future income.

b. Other Relevant Reliefs

  • Annual Investment Allowance (AIA): 100% deduction on qualifying plant and machinery.
  • Research and Development (R&D) Tax Relief: Includes tax reduction and cash credits for qualifying R&D.

4. Calculating Corporation Tax Liability

Apply the current tax rate to total taxable profits, covering both income profits and chargeable gains.

Strategic Application of Reliefs

Loss Relief Mechanisms

Applying loss relief effectively minimizes tax burdens:

  1. Carry-forward relief: Used indefinitely against future profits.
  2. Carry-back relief: Applied to the previous year's earnings.
  3. Group relief: Transfers losses between group companies.
  4. Terminal loss relief: Backdates losses over the final 12 months of trading.

Capital Allowances

Capital allowances offer tax relief on asset expenditure:

  1. Annual Investment Allowance (AIA): Full relief on qualifying assets up to £1 million.
  2. Writing Down Allowances (WDA): For amounts over the AIA limit.
  3. Structures and Buildings Allowance (SBA): 3% relief on non-residential properties.

Research and Development (R&D) Relief

R&D relief incentivizes innovation:

  1. SME R&D Relief: Offers a 230% deduction.
  2. Research and Development Expenditure Credit (RDEC): A 13% taxable credit for large companies.

Anti-Avoidance Measures

For SQE1 FLK1 candidates, key provisions include:

  1. General Anti-Abuse Rule (GAAR): Against abusive tax arrangements.
  2. Diverted Profits Tax: Targets profit diversion from the UK.
  3. Controlled Foreign Company (CFC) Rules: Prevents profit shifting to low-tax zones.
  4. Transfer Pricing: Ensures fair transaction pricing between related entities.

Recent Developments and Future Considerations

Corporation Tax Rate Changes

The rate increased from 19% to 25% for companies with profits over £250,000 from 1 April 2023, with marginal relief for profits between £50,000 and £250,000.

Brexit Effects

Changes include:

  1. VAT treatment of goods and services
  2. Customs duties
  3. Application of EU Directives

Environmental Measures

New initiatives include:

  1. Plastic Packaging Tax
  2. Enhanced allowances for electric vehicle charge points

Examples and Applications

Example 1: Allowable Expenses

"Tech Solutions Ltd" had £1 million in revenue and incurred:

  • Salaries: £400,000
  • Rent: £50,000
  • Utilities: £20,000
  • Materials: £100,000
  • Marketing: £80,000
  • Professional fees: £50,000

Calculation:

Total Expenses: £700,000
Taxable Profit: £300,000

Example 2: Chargeable Gain Calculation

"Tech Solutions Ltd" sold equipment for £50,000, originally purchased for £30,000, with £2,000 in fees.

Calculation:

Net Gain: £18,000

Example 3: Strategic Loss Relief

ABC Ltd's results:

  • 2022: £500,000 Profit
  • 2023: £300,000 Loss
  • 2024: £400,000 Profit

Options:

  1. Carry back to 2022, generating a tax refund.
  2. Carry forward to 2024.

The choice depends on cash flow needs and future prospects.

Conclusion

Understanding corporation tax is vital for SQE1 FLK1 success and a legal career. This guide outlined the basis of charge, calculation methods, use of reliefs, and anti-avoidance rules. Staying updated on legislative changes remains essential for effective corporate tax advising.

Key points:

  1. Corporation tax covers various income and gains.
  2. Calculations involve profits, gains, and reliefs.
  3. Loss relief and capital allowances can reduce tax liabilities.
  4. Anti-avoidance policies are central to tax strategy.
  5. Recent changes affect tax practice.