Introduction
At this point in our studies we turn to corporation tax, covering the basic
corporation tax rules in this chapter.
We start by looking at accounting periods, which are the periods for which
companies pay corporation tax. We then see how to bring together all of a
company’s profits in a corporation tax computation and discuss the special
rules for certain types of income that apply to companies.
In the next chapter, we will deal with the rules on chargeable gains for
companies.
Study guide
| Intellectual level | ||
| 4 | Corporation tax liabilities in situations involving further overseas and group aspects and in relation to special types of company, and the application of additional exemptions and reliefs | |
| (a) | The contents of the Paper F6 study guide, for corporation tax, under headings: | 2 |
| | E1 The scope of corporation tax | |
| | E2 Taxable total profits | |
| | E6 The use of exemptions and reliefs in deferring and minimising corporation tax liabilities | |
| (c) | Taxable total profits: | 3 |
| (i) | Identify qualifying research and development expenditure, both capital and revenue, and determine the reliefs available by reference to the size of the individual company/group | |
| (ii) | Recognise the relevance of a company generating profits attributable to patents | |
| (iii) | Identify the enhanced capital allowances available in respect of expenditure in respect of expenditure on green technologies, including the tax credit available in the case of a loss making company | |
| (v) | Recognise the alternative tax treatments of intangible assets and conclude on the best treatment for a given company | |
| (vi) | Advise on the impact of the transfer pricing and thin capitalisation rules on companies |
Exam guide
Although you are unlikely to get a question requiring a detailed computation of taxable total profits you may be asked to comment on how certain types of income would be included in the computation where there are special rules, such as for loan relationships, intangible fixed assets and research and development expenditure. You may also be asked to discuss how the transfer pricing rules work. It is less likely that you will be examined in detail on the more straightforward adjustments to profits or the rules for capital allowances.
This chapter revises the scope of corporation tax and the basic computation of taxable total profits. The examination team has identified essential underpinning knowledge from the F6 syllabus which is particularly important that you revise as part of your P6 studies. In this chapter, the relevant topic is:
| E2 | Taxable total profits | |
| (h) | Recognise and apply the treatment of interest paid and received under the loan relationship rules | 1 |
There are no changes in the material covered in F6 in Financial Year 2015 from Financial Year 2014.
There are two new topics: intangible fixed assets (including the patent box) and research and development.
1 The scope of corporation tax
1.1 Introduction
FAST FORWARD
Companies pay corporation tax on their taxable total profits of each accounting period.
Corporation tax is paid by companies. It is charged on the taxable total profits of each accounting period. For the purposes of the P6(UK) exam, corporation tax is not charged on dividends received from UK resident or non-resident companies.
Key term A ‘company‘ is any corporate body (limited or unlimited) or unincorporated association eg sports clubs.
1.2 The residence of companies
A company incorporated in the UK is resident in the UK. A company incorporated abroad is resident in the UK if its central management and control are exercised here.
1.3 Accounting periods
FAST FORWARD
An accounting period cannot exceed twelve months in length. A long period of account must be split into two accounting periods, the first of which is twelve months long.
Corporation tax is chargeable in respect of accounting periods. It is important to understand the difference between an accounting period and a period of account. A period of account is any period for which a company prepares accounts; usually this will be 12 months in length but it may be longer or shorter than this. An accounting period starts when a company starts to trade, or otherwise becomes liable to corporation tax, or immediately after the previous accounting period finishes. An accounting period finishes on the earliest of:
- 12 months after its start
- The end of the company’s period of account
- The company starting or ceasing to trade
- The company entering/ceasing to be in administration (see later in this Text)
- The commencement of a company’s winding up (see later in this Text)
- The company ceasing to be resident in the UK
- The company ceasing to be liable to corporation tax
In many cases, the company will have a period of account of 12 months and an accounting period of 12 months. We will deal with long periods of account (exceeding 12 months) later in this chapter.
2 Taxable total profits 12/13, 12/14, 9/15
| Taxable total profits are the total profits (income and gains) less some losses and qualifying charitable donations. |
FAST FORWARD
|
2.1 Introduction
The corporation tax computation draws together all of the company’s income and gains from various
| sources. The income from each different type of source must be computed separately because different | |
| computational rules apply. These rules are set out in the Corporation Tax Act 2009.
The taxable total profits for an accounting period are derived as follows. |
|
| £ | |
| Trading income | X |
| Property business income | X |
| Interest income from non-trading loan relationships | X |
| Miscellaneous income | X |
| Chargeable gains | X |
| Total profits | X |
| Less losses relieved by deduction from total profits | (X) |
| Less qualifying charitable donations | (X) |
| Taxable total profits for an accounting period
Each of the above items is dealt with in further detail later in this Text. |
X |
Exam focus You should be familiar with this proforma from your F6(UK) studies. The calculation of taxable total profits point may also be required in the P6(UK) exam, so you must understand how different types of income and gains are dealt with.
Dividends received from both UK and non-UK resident companies are usually exempt and so not included in taxable total profits.
Exam focus The examination team has stated that dividends which are taxable in the hands of the recipient company point are not examinable in the P6(UK) exam.
2.2 Trading income
The trading income of companies is derived from the profit before taxation shown in the accounts. The adjustments that need to be made to the accounts are broadly the same for companies as they are for income tax purposes (companies cannot use the cash basis) (see Chapter 6). Companies may also claim relief for the expenses of managing their investments (see Chapter 25). Where shares in UK companies are held as trading assets, and not as investments, any dividends on those shares will be treated for tax purposes as trading profits.
Qualifying charitable donations are added back into calculation of adjusted profit. They are instead deducted from total profits (see below).
Interest received on a trading loan relationship (see later in this chapter) is included within trading profits on an accruals basis. Similarly, interest paid on a trading loan relationship is deducted at arriving at trading profits.
Exam focus When adjusting profits as supplied in a statement of profit or loss confusion can arise as regards to point whether the figures are net or gross. Properly drawn up company accounts should normally include all
income gross. However, some examination questions include items ‘net’. Read the question carefully.
Pre-trading expenditure incurred by the company within the seven years before trade commences is treated as an allowable expense incurred on the first day of trading provided it would have been allowable had the company been trading when the expense was actually incurred.
Trading income also includes post cessation receipts arising from a trade which would not otherwise be chargeable to tax.
The calculation of capital allowances follows income tax principles. However, for companies, there is never any restriction of allowances to take account of any private use of an asset. The director or employee suffers a taxable benefit instead.
2.3 Property business income 9/15
The taxation of UK property business income follows similar rules to those for income tax (see earlier in this Text). In summary:
- All UK rental activities are treated as a single source of income calculated in the same way as trading profits.
- Capital allowances on plant and machinery (but not furniture) are taken into account when computing property income or losses.
However interest paid by a company on a loan to buy or improve property is not a property income expense. The loan relationship rules apply instead (see later in this chapter).
2.4 Interest income
UK companies normally receive interest gross. Interest relating to non-trading loan relationships is taxed separately as interest income on an accruals basis (see later in this chapter for the loan relationship rules).
2.5 Miscellaneous income
Income and expenditure relating to intellectual property, which is not used in the trade nor in a property business, are dealt with as miscellaneous income. We consider intellectual property in more detail later in this chapter.
2.6 Chargeable gains
Companies do not pay capital gains tax. Instead their chargeable gains are included in the taxable total profits. We look at companies’ chargeable gains in the next chapter.
2.7 Qualifying charitable donations
Qualifying charitable donations are deductible from total profits when computing taxable total profits.
Almost all donations of money to charity by a company can be qualifying charitable donations whether they are single donations or regular donations. There is no need for a claim to be made in order for a payment to be treated as a qualifying charitable donation (compare with gift aid donations where a declaration is required).
Donations to local charities which are incurred wholly and exclusively for the purposes of a trade are deducted in the calculation of the tax adjusted trading profits.
The following is a summary of the statement of profit or loss of A Ltd for the year to 31 March 2016.
| £ | £ | |
| Gross profit | 180,000 | |
| Other income | ||
| Treasury stock interest (non-trading investment) | 700 | |
| Dividends from UK companies (net) | 3,600 | |
| Loan interest from UK company (non-trading investment) | 4,000 | |
| Building society interest received (non-trading investment) | 292 | |
| Expenses | ||
| Trade expenses (all allowable) | 62,000 | |
| Qualifying charitable donation paid | 1,100 |
)
Profit before taxation
The capital allowances for the period total £5,500. There was also a chargeable gain of £13,867. Compute the taxable total profits.
| £ | £ | |
| Profit before taxation | 125,492 | |
| Less Treasury stock interest | 700 | |
| dividends received | 3,600 | |
| building society interest | 292 | |
| loan interest received | 4,000 | |
| (8,592) | ||
| 116,900 | ||
| Add qualifying charitable donation | 1,100 | |
| 118,000 | ||
| Less capital allowances | (5,500) | |
| Trading income | 112,500 | |
| Interest income £(700 + 292 + 4,000) | 4,992 | |
| Chargeable gain | 13,867 | |
| Total profits | 131,359 | |
| Less: qualifying charitable donation | (1,100) | |
| Taxable total profits | 130,259 |
2.8 Long periods of account
If a company has a long period of account, exceeding 12 months, it is split into two accounting periods: the first 12 months and the remainder.
Where the period of account differs from the corporation tax accounting periods, profits are allocated to the relevant periods as follows:
- Trading income before capital allowances and property income are apportioned on a time basis.
- Capital allowances and balancing charges are calculated for each accounting period.
- Other income is allocated to the period to which it relates (eg interest to the period when accrued). Miscellaneous income, however, is apportioned on a time basis.
- Chargeable gains and losses are allocated to the period in which they are realised.
- Qualifying charitable donations are deducted in the accounting period in which they are paid.
|
|||||||||||||||||||||
The 18 month period of account is divided into:
Year ending 31 December 2015 6 months to 30 June 2016
Results are allocated:
Y/e 6m to
31.12.15 30.6.16
£ £
Trading profits 12:6 120,000 60,000
Interest income
12 £500 6,000
6 £500 3,000
Capital gain (1.5.16) 250,000
Total profits 126,000 313,000
Less qualifying charitable donation (31.12.15) (50,000)
Taxable total profits 76,000 313,000
| 3 Loan relationships | 6/15 |
FAST FORWARD
A loan relationship arises when a company lends or borrows money. Trading loan relationships are dealt with as trading income. Non-trading loan relationships are dealt with as interest income.
3.1 Introduction
If a company borrows or lends money, including issuing or investing in loan stock or buying gilts, it has a loan relationship. This can be a creditor relationship (where the company lends or invests money) or a debtor relationship (where the company borrows money or issues securities). The loan relationship rules apply to both revenue and capital items.
3.2 Trading loan relationships
If the company is a party to a loan relationship for trade purposes, any debits, ie interest payable or other debt costs, charged through its accounts are allowed as a trading expense and are therefore deductible in computing trading profits. For example, a company paying interest on a loan taken out to purchase plant and machinery, or a factory or office premises for use in the trade will be able to deduct the interest payable for tax purposes.
Similarly if any credits, ie interest income or other debt returns, arise on a trading loan these are treated as a trading receipt and are taxable as part of trading profit. This is not likely to arise unless the trade is one of money lending so will usually fall within the rules for non-trading loan relationships (below).
3.3 Non-trading loan relationships
If the company is a party to a loan relationship for non-trade purposes, any debits and credits must be pooled. For example, a company paying interest on a loan taken out to purchase an investment property will not be able to deduct the interest from trading profits for tax purposes. Instead this ‘non-trade debit’ must be netted off against ‘non trade credits’ such as bank interest.
A net credit (ie income) on the pool is chargeable as interest income. Relief is available if there is a net ‘deficit’ (ie loss) (see later in this Text).
3.4 Example: loan relationships
During its year ended 31 December 2015 Jello Ltd received bank interest of £13,500 and loan stock interest from Wobble Ltd of £45,400. It also paid loan stock interest of £40,000 to Shaker Ltd on a loan of £1,000,000. The loan stock was issued to Shaker Ltd in May 2014 to raise £700,000 for the purchase of a factory to use in the trade and £250,000 for the purchase of an investment property. The balance was used as working capital. All figures are stated gross and are the amounts shown in the accounts.
The loan stock interest payable to Shaker Ltd was used partly for trade purposes, and partly for non trade purposes and must be apportioned:
| £ | |
| Non-trade purposes 250,000 £40,000/1,000,000 | 10,000 |
Trade purposes (700,000 + 50,000 (bal)) = 750,000 40,000/1,000,000
Total interest payable
The £30,000 of interest paid for trade purposes is deducted in the computation of trading profits.
The £10,000 of interest paid for non-trade purposes is deducted from non-trading interest received. The amount taxable as a non-trading loan relationship credit is:
| £ | |
| Bank interest (received gross) | 13,500 |
Debenture interest receivable from Wobble Ltd
| Non-trade loan stock interest paid to Shaker Ltd | (10,000) |
| Non-trading loan relationship credit | 48,900 |
3.5 Incidental costs of loan finance
Under the loan relationship rules expenses (‘debits’) are allowed if incurred directly:
- Bringing a loan relationship into existence (eg loan arrangement fees)
- Entering into or giving effect to any related transactions
- Making payment under a loan relationship or related transactions, or
- Taking steps to ensure the receipt of payments under the loan relationship or related transaction.
A related transaction means ‘any disposal or acquisition (in whole or in part) of rights or liabilities under the relationship, including any arising from a security issue in relation to the money debt in question’.
The above categories of incidental costs are also allowable even if the company does not enter into the loan relationship (ie abortive costs). Cost directly incurred in varying the terms of a loan relationship are also allowed.
3.6 Other matters
It is not only the interest costs of borrowing that are allowable or taxable. The capital costs are treated similarly. Thus if a company issues a loan at a discount and repays it eventually at par, the capital cost is allowed over the life of the loan.
Relief for pre-trading expenditure extends to expenses incurred on trading loan relationships in accounting periods ending within seven years of the company starting to trade. An expense that would have been a trading debit if it was incurred after the trade had commenced, is treated as a trading debit of the first trading period. An election has to be made within two years of the end of the first trading period.
Interest charged on underpaid tax is deductible and interest received on overpaid tax is assessable under the loan relationship rules as interest income.
4 Intangible fixed assets 6/12
4.1 Definition
Intangible fixed assets are defined for taxation purposes in the same way as for accounting purposes.
Examples include:
- Intellectual property (eg patents, copyrights)
- Goodwill
- Marketing-related intangible assets (eg registered trademarks, internet domain names) (d) Customer-related intangible assets (eg customer lists, customer relationships).
Exam focus Exam questions in this area will normally cover goodwill and/or patents.
point
4.2 Tax treatment of patents
FAST FORWARD
Gains/losses arising on patents are recognised for tax purposes on the same basis as they are recognised in the accounts.
4.2.1 Patents used for trading purposes
If the patent is used for trading purposes, any income or expenditure (including depreciation or amortisation) associated with patents is taxable/deductible as trading income. Provided the accounts have been prepared using generally accepted accounting practice, this means that no adjustment will be needed to the profit before taxation for tax purposes.
There is one exception to this. Instead of deducting the depreciation or amortisation as shown in the accounts the company may claim a writing down allowance of 4%. Such a claim might be made if, for example, the company did not charge amortisation on the patent.
As for loan relationships, the rules apply to capital debits and credits as well as revenue items. For example, on the disposal of the patent, a taxable credit or allowable debit arises which is the difference between the proceeds received and the tax written down value of the patent. The tax written down value will be the same as the accounts value (except where the 4% writing down allowance has been claimed) ie the tax treatment on disposal follows the accounting treatment.
Other intangible fixed assets (except for goodwill and customer-related intangible assets dealt with in section 4.3 later in this chapter) are treated for tax purposes in a similar way to patents.
Moon Ltd prepares accounts to 31 December each year. It sold a patent to an unrelated company on 1 December 2015 for £28,000. Moon Ltd had acquired the patent for use in its trade on 1 December 2013 for £25,000. The patent is being written off in Moon Ltd’s accounts on a straight-line basis over a ten-year period. What are the corporation tax implications of the sale of the patent?
The patent is an intangible fixed asset. On a disposal of the patent, the sales proceeds will be compared with theamortised cost.
£ £
Proceeds 28,000 Cost 25,000
Less amortisation £25,000 10% 2 (5,000)
(20,000)
Profit on sale 8,000
The profit on sale is a credit which will be included as part of Moon Ltd’s trading income because the patent was purchased for the purposes of the trade.
4.2.2 Patents used for non-trading purposes
If the patent is used for non-trade purposes, credits and debits are netted off. A net credit is taxable as miscellaneous income. A claim can be made for the whole or part of a net debit to be set off against total profits in the accounting period or a claim can be made for group relief. Any remaining debit is carried forward to the next accounting period as a non-trading debit of that period.
4.3 Tax treatment of goodwill NEW
FAST FORWARD
No debits (amortisation or impairment) on goodwill are allowable for tax purposes except on disposal. On a disposal of goodwill, a credit is taxable as trading income but a debit is a non-trading debit.
Exam focus The following tax treatment applies to goodwill acquired on or after 8 July 2015. From 1 September 2016, point in relation to goodwill, only these rules will be examinable in P6(UK).
In relation to goodwill, no debits (eg amortisation) are brought into account for tax purposes. Where amortisation has been deducted in the accounts, this must be added back in calculating the taxadjusted trading profit (as for unincorporated businesses).
On a disposal of goodwill, a credit or debit must be calculated which is the difference between the proceeds received and the original cost of the goodwill. A credit is taxable as trading income. A debit is a non-trading debit which can be relieved as explained in section 4.2.2 above.
Customer-related intangible assets are treated for tax purposes in a similar way to goodwill.
Star Ltd prepares accounts to 31 March each year. Star Ltd had purchased goodwill from an unrelated company on 1 August 2015 for £80,000. The goodwill has not been amortised in the company’s accounts. Star Ltd sold the goodwill to an unrelated company on 1 March 2016. In the year to 31 March 2016 Star Ltd had trading profits (before taking account of the sale of goodwill) of £15,000 and a chargeable gain of £3,000.
What are Star Ltd’s taxable total profits for the year to 31 March 2016 if the sale proceeds of the goodwill are:
(a) £100,000: or (b) £55,000?
Assume that Star Ltd claims relief for debits as soon as possible. Briefly explain how any remaining debit at 31 March 2016 will be dealt with.
- Proceeds of £100,000
£
Trading profit before sale of goodwill 15,000 Trading credit on sale of goodwill £(100,000 – 80,000) 20,000
Trading income 35,000 Chargeable gain 3,000
Total profits/taxable total profits 38,000
- Proceeds of £55,000
£
Trading profit before sale of goodwill 15,000
Chargeable gain 3,000 Total profits 18,000
Less non-trading debit on sale of goodwill
£(55,000 – 80,000) = £(25,000) restricted to total profits (18,000)
Taxable total profits 0
The remaining debit of £(18,000 – 25,000) = £(7,000) is carried forward to the next accounting period as a non-trading debit of that period.
4.4 Replacement of business assets relief
When an intangible fixed asset is disposed of, a claim for replacement of business assets relief may be made similar to that for chargeable gains. Details are covered when we look at rollover relief for chargeable gains in companies.
4.5 Patent box 12/14
| A company that makes a patent box election is taxed at a reduced rate of corporation tax on its patent box profits. |
FAST FORWARD
4.5.1 Introduction
Companies that own patents can elect for the profits relating to those patents to arise within a ‘patent box’.
The scheme applies to all profits attributable to qualifying patents. Such profits include royalty income received directly from the patents, but may also include a proportion of the profits from the sale of products where the patent has been used in their production. In order to qualify, the company must carry on ‘qualifying development’ in relation to the patent, which includes development of the patent itself or of products incorporating the patent.
The rules are being phased in over time but broadly the aim is that a company that makes a patent box election will only be taxed at an effective rate of 10% on its patent box profits. The relief is given by granting a tax deduction in the calculation of taxable total profits such that the effective rate of tax on the patent box profit is 10%. We look at the usual calculation of corporation tax later in this Text and you might want to revisit this section then.
4.5.2 Operation of the patent box
The first task is to determine the patent profit. This figure is then subject to a number of deductions in order to arrive at the net patent profit.
Exam focus You will not be required to calculate the patent profit or to apply the necessary deductions: the net patent point profit will be provided in the exam question.
The reduced rate of tax is arrived at by deducting an amount from the company’s taxable profits such that when the corporation tax rate is applied to the reduced figure, the effective rate is 10% on the patent profits.
In FY 2015 only 80% of the profit within the patent box is taxed at the 10% rate, so the deduction is calculated as follows:
(MR 10%)
Net patent profit 80% MR
where MR is the main rate of corporation tax. The main rate of corporation tax in financial year 2015 is 20%.
Exam focus The basic formula will be provided in the Tax rates and Allowances available in the exam. You will be point provided with the appropriate percentage to apply to the net patent profit if required in a question.
Blue plc prepares accounts to 31 March each year. In the year ending 31 March 2016, it had taxable total profits (before the patent box adjustment) of £1,800,000, of which the net patent profit was £220,000. Calculate the corporation tax liability of Blue plc for the year ending 31 March 2016 assuming that it makes a patent box election. The relevant percentage for FY 2015 is 80%.
| £ | £ | |
| Profit other than net patent profit £(1,800,000 – 220,000) | 1,580,000 | |
| Net patent profit | 220,000 | |
| Less Deduction in respect of patent profit
20%10% £220,000 80% 20% |
(88,000) |
|
| 132,000 | ||
| Taxable total profits | 1,712,000 | |
| Corporation tax liability £1,712,000 20% | 342,400 |
| Note: The corporation liability can be analysed as follows. | |
| £ | |
| Net patent profit @ 10% | |
| £(220,000 80%) = £176,000 10% | 17,600 |
| Balance of taxable profits | |
| £(1,800,000 – 176,000) = £1,624,000 20% | 324,800 |
| Corporation tax liability | 342,400 |
5 Transfer pricing 12/13
FAST FORWARD
The transfer pricing legislation prevents manipulation of profits between members of a group which can occur when a company chooses to buy and sell goods at a price which is not a market price.
5.1 General rules
Companies under common control can structure their transactions in such a way that they can shift profit (or losses) from one company to another. For example consider a company which wishes to sell goods valued at £20,000 to an independent third party.
Selling Goods invoice Buying company value: £20,000 company
In this case all the profit on the sale arises to the selling company. Alternatively the sale could be rearranged:
Goods Goods
Selling invoice Subsidiary invoice Buying company value: company value: company
£16,000 £20,000
In this case £4,000 of the profit has been diverted to the subsidiary.
This technique could be used to direct profits to a company where they can be sheltered by losses brought forward, or even to an overseas company paying tax at a lower rate. This is a ‘tax advantage’ and there is anti avoidance legislation which requires the profit to be computed as if the transactions had been carried out at arm’s length and not at the prices actually used. This is called a transfer pricing adjustment.
The transfer pricing rules apply to transactions between two persons if either:
(a) one person directly or indirectly participates in the management, control or capital of the other, or (b) a third party directly or indirectly participates in the management, control or capital of both.
Where a transfer pricing adjustment is required to the tax computation of a company subject to UK corporation tax and the other person to the transaction (who is disadvantaged) is within the charge to UK tax, a claim can be made to amend the tax computation of the disadvantaged person to arm’s length basis, in place of the actual price used. The claim must be made within two years from the date of the return which includes the transfer adjustment.
5.2 Exemption for small and medium sized enterprises
Small and medium-sized enterprises (SMEs) are normally exempt from the transfer pricing requirements.
The definition of SMEs for the purposes of the transfer pricing rules are that the number of staff must be less than, and either the turnover or the balance sheet total not more than, the limits in the table below:
| Staff | Turnover | Balance Sheet | |
| Small | 50 | €10M (about £8.5m) | €10M (about £8.5m) |
| Medium | 250 | €50M (about £42.5m) | €43M (about £36.5m) |
The exemption does not apply to transactions with parties which are resident in a non-qualifying territory. This includes most foreign countries which do not have a double tax treaty with the UK, and certain other designated countries.
HMRC may direct that a medium sized enterprise should be brought within the scope of the legislation.
5.3 Transactions affected
The rules apply to all types of transactions. This includes not only the simple cases of sales of goods or provision of services, but also loans. A transfer pricing adjustment may be required if the loan would not have been made between the companies had there not been a relationship between them, or if a different amount would have been lent, or if the interest rate would have been different. Thus an adjustment to the interest charged in the accounts would be needed if the loan was sufficiently large that in an arm’s length situation the lending company would have required equity, ie shares, instead of the loan. This situation is referred to as ‘thin capitalisation‘.
5.4 Tax implications
Companies must self-assess their liability to tax under the transfer pricing rules and pay any corporation tax due. A statutory procedure exists for advance pricing arrangements (APAs) whereby a company can agree in advance that its transfer pricing policy is acceptable to HMRC ie not requiring a self-assessment adjustment. The APA facility is voluntary but companies may feel the need to use the facility as it provides necessary advance confirmation that their approach to transfer pricing in their selfassessment is acceptable.
6 Research and development 6/12, 9/15
FAST FORWARD
Companies can claim a deduction for the actual amount of revenue and capital expenditure on research and development. SMEs can obtain 230% relief for qualifying research and development expenditure and large companies may obtain 130% relief. There is an alternative ‘above the line’ tax credit for large companies.
6.1 General rules
Research and development expenditure of a revenue nature may be deducted as allowable expenditure if it is related to the company’s trade and the activity is undertaken by the company or on its behalf.
‘Research and development’ covers any activities that would be described as such under generally accepted accounting practice. It is related to the trade if it will lead to an extension of the trade or is directed towards the medical welfare of workers employed in the trade. The definition does not cover expenditure incurred on acquiring rights arising from research and development.
Expenditure of a capital nature on research and development related to the company’s trade is also wholly allowable as a deduction ie 100% allowances are available. This covers capital expenditure on the provision of laboratories and research equipment. Note, however, that no allowance is available for expenditure on land. If any proceeds are received from the disposal of the capital assets, that receipt is taxable as trading income.
6.2 R&D relief: SMEs
A small or medium sized enterprise which incurs research and development expenditure of a specific nature may claim R&D tax relief.
The general definition of an SME for R&D purposes is the same as for the transfer pricing rules (see above). The definition of SME has also been extended to companies (‘larger SMEs’) with fewer than 500 employees, an annual turnover not exceeding €100 million and/or an annual balance sheet not exceeding €86 million. An SME must not be owned as to 25% or more by a non-SME.
Exam focus It will be stated whether or not a company is a SME for R&D purposes in examination questions.
point
Research and development expenditure which qualifies for the relief is revenue expenditure on:
- staff costs, ie salaries (but not benefits), pension contributions and employer’s Class 1 NICs
- software and consumable items, including fuel, power and water
- subcontracted expenditure of the same nature, and
- expenditure on externally related workers. Unless the workers are provided by a connected company this is limited to 65% of the amounts paid in respect of these workers.
R&D relief for SMEs is given by allowing the company to claim 230% of the expenditure as a deduction instead of the actual cost.
6.3 R&D tax credits
A company qualifying for SME R&D relief may claim a tax credit if it has a surrenderable loss.
The surrenderable loss is the lower of:
(a) the company’s unrelieved trading loss; and (b) 230% of qualifying R&D expenditure.
The unrelieved trading loss is defined as the company’s trading current period loss less any current period loss relief claim that could be made (whether or not such a claim is actually made) and any actual carry back claim and group relief claim (see later in this Text).
The credit is 14.5% (FY 2015) of the surrenderable loss. The tax credit will be paid to the company by HMRC or set against any corporation tax liability.
The trading loss then carried forward is reduced by the amount of the loss surrendered.
Saturn Ltd is a small enterprise for the purposes of research and development. It was incorporated and started trading on 1 April 2015. During the year to 31 March 2016, it made a tax adjusted trading loss of £(100,000) before taking into account research and development expenditure of £30,000. It has no other income or gains.
Explain the tax deductions and/or credits available in the year ending 31 March 2016 in respect of the R&D expenditure and comment on any choices available to Saturn Ltd.
Since Saturn Ltd is a small enterprise for the purposes of research and development, the expenditure of £30,000 will result in a tax deduction of £30,000 × 230% = £69,000. This will result in an increase in the loss of £69,000 which it must carry forward against future profits of the same trade since it has no other income or gains in the current period (and has no previous accounting periods since this is its first accounting period).
Saturn Ltd can choose to claim tax credit of 14.5% of the lower of its surrenderable loss, which is the lower of the trading loss (£169,000) and £69,000, as an alternative to carrying the loss forward. This is therefore 14.5% × £69,000 = £10,005.
Saturn Ltd should consider claiming the 14.5% tax credit if cash flow is its main priority. Alternatively, if the company wishes to maximise the tax saved in respect of the expenditure, it should carry the loss forward. It will then save tax at 20% (provided it succeeds in becoming profitable).
| R&D tax credits were tested in June 2012 Question 5 Kurt Ltd. The examiner commented that ‘the tax treatment of the expenditure on scientific research was explained well by the majority of candidates, many of whom were aware that there was a possibility of claiming a [14.5%] repayment. However, very few candidates attempted to evaluate whether or not the repayment should be claimed.’ |
Exam focus point
6.4 R&D relief: large companies
6.4.1 Deduction relief
A large company, ie one which is not an SME, that incurs research and development expenditure of a specific nature may claim a less generous R&D tax relief.
Research and development expenditure which qualifies for the relief is revenue expenditure on:
- staff costs, software and consumable items, and expenditure on externally related workers in connection with its own research or with research subcontracted to the company by a large company or non-trading organisation
- expenditure of the same nature subcontracted by the company to a research organisation, an individual or a partnership of individuals.
R&D relief for large companies is given by allowing the company to claim 130% of the expenditure as a deduction instead of the actual cost.
6.4.2 Above the line (ATL) tax credit
An alternative ‘above the line’ (ATL) credit for large company research and development (R&D) investment can be claimed.
The company must elect for the ATL tax credit within two years of the end of the accounting period. Once the company has claimed the ATL tax credit method it cannot claim deduction relief for future accounting periods.
The credit is 11% (FY 2015) of R&D expenditure. It is a taxable receipt but is also a credit against the company’s corporation tax liability.
For companies with no corporation tax liability:
- The tax credit is paid net of corporation tax,
- The amount of tax credit it can receive is limited to the PAYE/NIC liabilities of the company’s R&D staff.
Any amount above this PAYE/NIC cap is carried forward and treated as a tax credit of the following accounting period. Alternatively the company can claim to offset the excess against the corporation tax liabilities of other accounting periods or of other group companies.
Innovative plc, a large company, spends £100,000 on qualifying R&D expenditure during the year to 31 March 2016. The company has taxable total profits of £2,135,000 before any deduction is taken for the R&D expenditure.
Calculate the company’s corporation tax liability for the year to 31 March 2016 if:
(a) The company claims the 30% additional R&D deduction, or (b) The company claims the ATL tax credit.
- If 30% additional R&D deduction claimed
£
Taxable total profit before R&D expenditure 2,135,000
Less R&D expenditure (100,000)
R&D additional deduction £100,000 30% (30,000)
Taxable total profit 2,005,000
Corporation tax payable £2,005,000 20% 401,000
Note: The tax saving on R&D expenditure is £100,000 30% 20% = £6,000 or 6% of the expenditure.
- If ATL tax credit claimed
£
Taxable total profit before R&D expenditure 2,135,000
Add ATL credit £100,000 11% 11,000
Less R&D expenditure (100,000)
Taxable total profit 2,046,000
Corporation tax £2,046,000 20% 409,200
Less ATL credit £100,000 11% (11,000)
| Note: The tax saving using the ATL credit is as follows: | |
| £ | |
| Corporation tax on additional income £11,000 20% | 2,200 |
| Less ATL credit deduced from CT liability £100,000 11% | (11,000) |
| Corporation tax saving (8.8% of R&D expenditure) | 8,800 |
Corporation tax payable 398,200
The additional tax saving by using the ATL credit is therefore £(401,000 – 398,200) = £2,800 which is ((8.8% – 6%) £100,000).
7 Enhanced capital allowances (ECAs)
| ECAs are available on energy-saving and water-saving plant and machinery. A company may surrender tax losses attributable to ECAs for a first year tax credit of 19% of the loss surrendered. |
FAST FORWARD
7.1 Availability of ECAs
As was described earlier in this Text, expenditure on energy saving or water saving plant and machinery qualifies for enhanced capital allowances of 100%.
7.2 Surrender of ECAs
Companies are able to surrender tax losses attributable to ECAs for a cash payment called a first-year tax credit.
The first-year tax credit is 19% of the loss surrendered, subject to an upper limit which is the greater of:
- the total of the company’s PAYE and NICs liabilities for the period for which the loss is surrendered; or
- £250,000.
Where the loss could be used by the company against its taxable profits in the same period or surrendered as group relief, then it cannot be surrendered for a first-year tax credit. Any losses available to carry forward are reduced by the amount of the loss that has been surrendered.
The company must claim first-year tax credits in its corporation tax return for the relevant accounting period.
There will be a claw-back of the relief if the ECA qualifying plant and machinery is sold within four years after the end of the period for which the tax credit was paid. If this happens, the surrendered loss will become available for relief again.
Chapter roundup
| | Companies pay corporation tax on their taxable total profits of each accounting period. |
| | An accounting period cannot exceed twelve months in length. A long period of account must be split into two accounting periods, the first of which is twelve months long. |
| | Taxable total profits are the total profits (income and gains) less some losses and qualifying charitable donations. |
| | A loan relationship arises when a company lends or borrows money. Trading loan relationships are dealt with as trading income. Non-trading loan relationships are dealt with as interest income. |
| | Gains/losses arising on patents are recognised for tax purposes on the same basis as they are recognised in the accounts. |
| | No debits (amortisation or impairment) on goodwill are allowable for tax purposes except on disposal. On a disposal of goodwill, a credit is taxable as trading income but a debit is a non-trading debit. |
| | A company that makes a patent box election is taxed at a reduced rate of corporation tax on its patent box profits. |
| | The transfer pricing legislation prevents manipulation of profits between members of a group which can occur when a company chooses to buy and sell goods at a price which is not a market price. |
| | Companies can claim a deduction for the actual amount of revenue and capital expenditure on research and development. SMEs can obtain 230% relief for qualifying research and development expenditure and large companies may obtain 130% relief. There is an alternative ‘above the line’ tax credit for large companies. |
| | ECAs are available on energy-saving and water-saving plant and machinery. A company may surrender tax losses attributable to ECAs for a first year tax credit of 19% of the loss surrendered. |
Quick quiz
- When does an accounting period end?
- How are trading profits (before capital allowances) of a long period of account divided between accounting periods?
- Does a company pay loan stock interest to another UK company gross or net of tax?
- How is interest arising on a non-trading loan relationship taxed?
- What steps can be taken against the use of artificial transfer prices?
- A small or medium sized company can claim ….% relief for qualifying research and development expenditure. Fill in the blank.
- X plc spends £100,000 on energy saving plant and machinery in the year to 31 March 2016. X plc has a trading loss of £500,000 for the year including the enhanced capital allowance on the energy saving plant and machinery. What first year tax credit can it claim?
Answers to quick quiz
- An accounting period ends on the earliest of:
- 12 months after its start
- the end of the company’s period of account
- the company starting or ceasing to trade
- the company entering/ceasing to be in administration
- the commencement of the company’s winding up
- the company ceasing to be resident in the UK
- the company ceasing to be liable to corporation tax
- Trading income (before capital allowances) is apportioned on a time basis.
- Interest on a non-trading loan relationship is aggregated with all other income and gains from non-trading loans. From this is deducted interest paid on and losses on non-trading loans. The resulting net amount is taxed as interest income.
- Although a company may buy and sell goods at any price it wishes, the transfer pricing anti-avoidance legislation requires profit to be computed as if the transactions had been carried out at arm’s length, in certain circumstances.
- A small or medium sized company can claim 230% relief for qualifying research and development expenditure.
- £100,000 100% 19% = £19,000 (less than upper limit of £250,000).
| Number | Level | Marks | Time |
| Q21 | Introductory | 15 | 29 mins |
