Introduction to Business Taxation ‘Finance Act 2005’ pot

Introduction to Business Taxation
‘Finance Act 2005’
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Introduction to
Business Taxation
‘Finance Act 2005’
Chris Jones, BA CTA (Fellow) ATT

AMSTERDAM • BOSTON • HEIDELBERG • LONDON • NEW YORK • OXFORD
PARIS • SAN DIEGO • SAN FRANCISCO • SINGAPORE • SYDNEY • TOKYO

Elsevier Butterworth-Heinemann
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CONTENTS

Preface
ix
CIMA Tax Tables
xi

A: Introduction to the UK Tax System 1
B: Computation of Taxable Trading Profit 9
B1: Trading Income and the Badges of Trade 9
B2: Adjustment of Profit 17
B3: Capital v Revenue 29
B4: Capital Allowances – Definition 37
B5: Capital Allowances – Computation 45
B6: Industrial Buildings Allowances 57
B7: Intangible Fixed Assets 73
B8: Research and Development Expenditure 79
B9: Tax Law and Accounting Practice 87
C: Taxation of Limited Companies 95
C1: Computation of Corporation Tax 95
C2: Associated Companies 103
C3: Short Accounting Periods 111
C4: Long Periods of Account 117
C5: Corporation Tax Self Assessment (CTSA) 127
C6: Payment of Corporation Tax 139
C7: Interest on Late Paid Tax 147
C8: CTSA Penalty Regime 153
C9: Income from Property 159
C10: Loan Relationships 163
C11: Relief for Trading Losses 171
C12: Relief for Other Losses 181
C13: Corporate Capital Gains 187

C14: Rollover Relief 197
C15: Shares and Securities: Matching Rules 205
C16: Substantial Shareholding Exemption 215
C17: The Principles of Group Relief 221
C18: Group Capital Gains 235
C19: Close Company Definition 247
C20a: Close Company Implications – Part 1 255

vi
Contents


C20b: Close Company Implications – Part 2 261
C21: Investment Companies 267
C22: Corporate Venturing Scheme 273
D: Employee Tax Matters 281
D1: Employed or Self Employed? 281
D2: Introduction to Employment Income & Benefits 289
D3: Company Car & Fuel Benefits 303
D4: Living Accommodation – Taxable Benefits 315
D5: Loans to Employees & Use of Assets 323
D6: Miscellaneous Benefits 331
D7: Expenses of Employment 341
D8: Calculating the Income Tax Liability 351
D9: Introduction to PAYE 359
D10: PAYE End of Year Returns 369
D11: Class 1 National Insurance Contributions 377
D12: Class 1A and 1B National Insurance Contributions 387
D13: Termination Payments 397
D14a: Occupational Pensions & Furbs 409

D14b: The New Pension Regime 415
D14c: The Enterprise Investment Scheme 417
E: Value Added Tax 425
E1: Overview of the VAT System 425
E2: Registration 431
E3: Definition of Supplies 441
E4: Liability of the Supply 445
E5: Schedule 8 VATA 1994 – Zero Rating 449
E6: Schedule 9 VATA 1994 – Exemptions 457
E7: Value of the Supply 461
E8: Deemed Supplies and Self-Supplies 473
E9: Time of Supply 483
E10a: Input Tax: When to Recover 491
E10b: Partial Exemption 495
E11: VAT Records and Returns 513
E12: Accounting for VAT 525
E13: Bad Debt Relief 539
E14: Control Visits, Appeals and Assessments 543
Contents
vii

E15a: Misdeclaration Penalty 557
E15b: Late Registration Penalty 563
E15c: Default Surcharge 569
E15d: Repeated Misdeclaration Penalty 577
E15e: Other Penalties, Interest and Mitigation 583
E16: Refunds, Repayment Supplement and Interest 595


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PREFACE
This book provides all the material you need for the CIMA Professional Development
Certificate in Business Taxation. Within each chapter you will find some examples for
you to try, to test you on the important rules covered in the chapter.
At the end of each chapter, there is a short summary which contains a “pocket digest”
of the rules covered within the chapter. These individual summaries form a
comprehensive overview of the syllabus.
As this manual has been written specifically to cover all areas of the syllabus we are
confident you will find this an invaluable tool leading to success in the examination.


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CIMA Tax Tables
xi

CIMA
Tax Tables

Income Tax rates 2005-06 2004-05
% %
Starting rate 10 10
Basic rate 22 22
Higher rate 40 40
£ £
Starting rate band 1 - 2,090 1 - 2,020
Basic rate band 2,091 - 32,400 2,021 - 31,400


Income Tax reliefs 2005-06 2004-05

£ £
Personal allowance 4,895 4,745



Income Tax – Pension contributions
Stakeholder / Personal pension premiums

Age %
Up to 35 17.5
36–45 20
46–50 25
51–55 30
56–60 35
61 or over 40

Age is taken at the start of the fiscal year
Pension Plan earnings cap 2005-06: £105,600 2004-05: £102,000
Stakeholder pension limit 2005-06: £3,600 2004-05: £3,600

Company cars and fuel
Company cars

Cash equivalent 15% of list price for cars emitting 140g/km (2005/06), 145g/km
(2004/05) Increased by 1% per 5g/km over the 140g/km/145g/km limit
Capped at 35% of list price
3% supplement on diesel cars not meeting the Euro IV emission
standards
(subject to 35% cap) or registered after 1 January 2006
Van scale charge

£500 (reduced to £350 if more than four years old at the end of the fiscal year).
There is no taxable benefit where an employee takes a van home but is not allowed any
other private use.
Fuel scale benefits
For 2005-06 (& 2004-05) the benefit is £14,400 multiplied by the percentage used in
calculating the car benefit (ie based on carbon dioxide emission rating)
xii
CIMA Tax Tables


HMRC Authorised Mileage Rates

2005-06 and 2004-05
Vehicles First 10,000 business
miles
Additional business miles
Car or van * 40p 25p
Motorcycles 24p
Bicycles 20p
Passenger payments 5p

* For NIC purposes, a rate of 40p applies irrespective of mileage.

Value Added Tax
Standard rate 17½%
Annual registration limit From 1 April 2004 £58,000
From 1 April 2005 £60,000
De-registration limit From 1 April 2004 £56,000
From 1 April 2005 £58,000

Annual accounting / cash accounting Post
31.3.04
£
Turnover threshold to join scheme 660,000
Turnover threshold to leave scheme 825,000
Capital allowances
Principal writing down allowance rates
Plant and machinery, patent rights and know-how 25%
Industrial buildings and Agricultural buildings 4%
Long life assets 6%

First year allowances available
Small-sized businesses 40% (1) (2)
Medium-sized businesses 40%

(1) 50% rate applies from 1 April 2004 to 31 March 2005 for companies.
(2) 50% rate applies from 6 April 2004 to 5 April 2005 for unincorporated businesses.

Small sized businesses

100% on computers and related equipment acquired between 1 April 2000 and
31 March 2004

First year allowances available to all businesses

100% on Energy Saving Plant acquired from 1 April 2001 (extended definition from
17 April 2002) and on designated water efficient plant from 1 April 2003
100% on cars registered between 16 April 2002 and 31 March 2008 if the car either
emits not more than 120g/km of C0
2

or it is electronically propelled.
100% on the renovation or conversion of vacant business premises, in any of the
disadvantaged areas of the UK designated as Enterprise Areas, for the purpose of bringing
those premises back into business use. (The Business Premises Renovation Allowance).
CIMA Tax Tables
xiii

Small and medium sized company limits
Small Medium
(i) Turnover £5.6m (£2.8m) £22.8m (£11.2m)
(ii) Balance sheet assets £2.8m (£1.4m) £11.4m (£5.6m)
(iii) Employees 50 250
Note. The figures in brackets apply to accounting periods ending prior to 30 January 2004.
Corporation Tax
Financial year 2004 and 2005
Full rate 30%
Small companies' rate 19%
Starting rate 0%
Profit limit for lower rate £10,000
Profit limit for lower rate marginal relief £50,000
Profit limit for small companies' rate £300,000
Profit limit for small companies' marginal relief £1,500,000
Marginal relief fraction for profits between 19/400
£10,000 and £50,000
Marginal relief fraction for profits between
£300,000 and £1,500,000 11/400
There is a minimum corporation tax charge of 19% on PCTCT distributed to non
corporate shareholders.
Research and Development expenditure and transfer pricing limits: small and medium
sized company limits

Small
Medium

Employees 50 250
Turnover ε10m ε50m
Balance sheet assets ε10m ε43m
National Insurance contributions

2005-06 2004-05
Class 1 contributions Annual Weekly Annual Weekly
Lower earnings limit £4,264 £82 £4,108 £79
Earnings threshold £4,895 £94 £4,745 £91
Upper earnings limit £32,760 £630 £31,720 £610

Employee’s contributions in 2005-06 (2004-05)
Not contracted out: 11% (11%) on earnings between £94 (£91) and £630
(£610)
1% (1%) above £630 (£610) per week
Contracted out: 9.4% (9.4%) on earnings between £94 (£91) and £630
(£610)
1% (1%) on earnings above £630 (£610) per week
1.6% rebate on earnings between £82 (£79) and £94 (£91)
Employer’s contributions in 2005-06 (2004-05)
Not contracted out: 12.8% (12.8%) on earnings in excess of £94 (£91)
xiv
CIMA Tax Tables


Contracted out: Salary related: 9.3% (9.3%) on earnings between £94 (£91) and
£630 (£610)

12.8% (12.8%) on earnings in excess of £630 (£610)
3.5% (3.5%) rebate on earnings between £82 (£79) and
£94 (£91)
Contracted out: Money purchase: 11.8% (11.8%) on earnings between £94 (£91) and
£630 (£610)
12.8% (12.8%) on earnings in excess of £630 (£610)
1% rebate on earnings between £82 (£79) and £94 (£91)

2005-06 2004-05
Class 1A contributions 12.8% 12.8%
Class 1B contributions 12.8% 12.8%
Class 2 contributions
Normal rate £2.10 pw £2.05 pw
Small earnings exception £4,345 pa £4,215 pa
Class 3 contributions £7.35 pw £7.15 pw
Class 4 contributions
Annual lower earnings limit £4,895 £4,745
Annual upper earnings limit £32,760 £31,720
Percentage rate between limits 8% 8%
Percentage rate above upper limit 1% 1%

Capital Gains
Retail Prices Index
Where Retail Price Indices are required, it should be assumed that they are as follows.
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
1982 – – 79.44 81.04 81.62 81.85 81.88 81.90 81.85 82.26 82.66 82.51
1983 82.61 82.97 83.12 84.28 84.64 84.84 85.30 85.68 86.06 86.36 86.67 86.89
1984 86.84 87.20 87.48 88.64 88.97 89.20 89.10 89.94 90.11 90.67 90.95 90.87
1985 91.20 91.94 92.80 94.78 95.21 95.41 95.23 95.49 95.44 95.59 95.92 96.05
1986 96.25 96.60 96.73 97.67 97.85 97.79 97.52 97.82 98.30 98.45 99.29 99.62

1987 100.0 100.4 100.6 101.8 101.9 101.9 101.8 102.1 102.4 102.9 103.4 103.3
1988 103.3 103.7 104.1 105.8 106.2 106.6 106.7 107.9 108.4 109.5 110.0 110.3
1989 111.0 111.8 112.3 114.3 115.0 115.4 115.5 115.8 116.6 117.5 118.5 118.8
1990 119.5 120.2 121.4 125.1 126.2 126.7 126.8 128.1 129.3 130.3 130.0 129.9
1991 130.2 130.9 131.4 133.1 133.5 134.1 133.8 134.1 134.6 135.1 135.6 135.7
1992 135.6 136.3 136.7 138.8 139.3 139.3 138.8 138.9 139.4 139.9 139.7 139.2
1993 137.9 138.8 139.3 140.6 141.1 141.0 140.7 141.3 141.9 141.8 141.6 141.9
1994 141.3 142.1 142.5 144.2 144.7 144.7 144.0 144.7 145.0 145.2 145.3 146.0
1995 146.0 146.9 147.5 149.0 149.6 149.8 149.1 149.9 150.6 149.8 149.8 150.7
1996 150.2 150.9 151.5 152.6 152.9 153.0 152.4 153.1 153.8 153.8 153.9 154.4
1997 154.4 155.0 155.4 156.3 156.9 157.5 157.5 158.5 159.3 159.5 159.6 160.0
1998 159.5 160.3 160.8 162.6 163.5 163.4 163.0 163.7 164.4 164.5 164.4 164.4
1999 163.4 163.7 164.1 165.2 165.6 165.6 165.1 165.5 166.2 166.5 166.7 167.3
2000 166.6 167.5 168.4 170.1 170.7 171.1 170.5 170.5 171.7 171.6 172.1 172.2
2001 171.1 172.0 172.2 173.1 174.2 174.4 173.3 174.0 174.6 174.3 173.6 173.4
2002 173.3 173.8 174.5 175.7 176.2 176.2 175.9 176.4 177.6 177.9 178.2 178.5
2003 178.4 179.3 179.9 181.2 181.5 181.3 181.3 181.6 182.5 182.6 182.7 183.5
2004 183.1 183.8 184.6 185.7 186.5 186.8 186.8 187.4 188.1 188.6 189.0 189.9
2005* 188.9 189.6 189.8 190.0 190.2 190.4 190.6 190.8 191.0 191.2 191.4 191.6
2006* 191.8 192.0 192.2 192.4 192.6 192.8 193.0 193.2 193.4 193.6 193.8 194.0
* = assumed
A: Introduction to the UK Tax System


In this chapter you will cover the following areas in overview:
- the various taxes levied in the UK;
- the period for which income tax is charged;
- the categorisation of sources of income;
- the sources of income that are exempt from income tax.

A1.1 Taxes in the UK

The UK government raises in the region of 230 to 250 billion pounds in taxation
each year.

Income tax is the single largest earner for the government making up 30% of
total revenue. Income tax is charged on salaries from employment, on rental
income from properties let out, on interest from banks and building societies, on
dividends from companies and on the profits of the self employed.

The second largest earner for the government is value added tax (VAT). This
makes up about 23% of the total government revenue and is charged by
businesses to customers on supplies of goods or services in the UK.

National Insurance contributions (NIC) make up 21% of total government
income. National Insurance contributions are generally paid by both employers
and employees on earnings from employment, although NIC is also levied on self
employed persons on the profits of their trade.

Income tax, VAT and NIC are the three most important taxes as far as raising
money is concerned, making up about 75% or so of total government revenue.

A large part of the remainder (16%), is made up of duties, being taxes on
alcohol, petrol and tobacco, as well as certain levies on goods coming into the UK.

Corporation tax makes up about 8% of total government revenue, being the tax
paid by UK companies on their taxable profits.

The remaining slice consists of the “capital taxes” being capital gains tax (CGT),
inheritance tax (IHT), stamp duty (SD) and stamp duty land tax (SDLT). Capital
gains tax is the tax levied when individuals sell assets and make a profit.





Introduction to Business Taxation ‘Finance Act 2005’

2
A1.2 The tax year

Individuals pay income tax by reference to the “tax year”. The UK tax year runs
from 6 April to the following 5 April. For example, the tax year that begins on
6 April 2005 and ends on 5 April 2006 is known as the tax year 2005/06.

The tax rates and tax allowances for the 2005/06 tax year, were set in the
March 2005 Budget.

There are two stages in calculating an individual’s tax liability. First we compute
the individual’s taxable income from all sources in the relevant tax year. Having
arrived at taxable income we then apply the 2005/06 tax rates and allowances
to that income, to arrive at the tax liability for the year. This tax will be
collected by the HM Revenue & Customs (“the Revenue”) under the “self-
assessment” system. This will be dealt with in a later chapter.

A1.3 Sources of income

The tax legislation categorises various sources of income. Each type of income

has its own special rules. This is why we need to decide what type of income an
individual has received.

When we looked at income received by individuals in the past, the types of
income were sorted into Schedules and sometimes further divided into Cases.
This was called the Schedular system. It still operates for companies and so we
will be looking at it in detail when we study companies. You may well find
references to the old system in past questions. So we will mention the main
points of the old system as we explain the current way of sorting out the types
of income.

The first type of income that we will think about is trading income. This covers
profits from a trade. So, for instance, a self employed person in business as a
taxi driver, or a market trader, or a builder or plumber, would be taxed on his
trading income. This used to be called Schedule D Case I income.

Trading income also covers profits from a profession or vocation. For instance, a
self employed professional such as a solicitor or barrister would also have
trading income. This used to be called Schedule D Case II income. Trading
income is a very important type of income and we will deal with it in a separate
module.

The second type of income we need to consider is property income. This is
income from land and buildings, such as rental income. We need to keep property
income from UK land and buildings separate from property income from non-UK
land and buildings. Income from UK land and buildings used to be taxed under
Schedule A. Income from non-UK land and buildings used to be taxed under
Schedule D Case V.

Introduction to the UK Tax System

3
Next, there is a very important type of income called income from earnings and
pensions. Earnings covers salaries, bonuses and non-cash benefits. We will look
at these in detail in later sessions. This type of income used to be taxed under
Schedule E.

There are various types of savings and investment income. A very common one is
interest arising from UK banks and building societies. We call this interest
income. This type of income used to be taxed under Schedule D Case III.

Another type of investment income is dividends received from companies. These
used to be taxed under Schedule F. As we will see later, dividend income needs
to be kept separate from other types of investment income because it has
different rates of tax applied to it.

These are the two main types of savings and investment income, but there are
some others which we will explain more about later in this course.

An individual may have income from outside the UK. We have already seen that
he may have property income from non-UK land and buildings. He may also have
investment income from outside the UK such as non-UK bank interest or non-
UK dividends. All income arising outside the UK is now called foreign income.
Foreign investment income used to be taxed under Schedule D Case V.

It is important to note here that income can still be taxable in the UK, even if it
arises from a source outside the UK. As a general principle, individuals who live
in the UK and who were born in the UK will pay UK income tax on their worldwide

income wherever it comes from. So, a UK resident will generally pay income tax
on foreign income.

Finally, there is income which is chargeable to income tax which does not fall
within any of the categories that we have just looked at. This is called
miscellaneous income. It is the Revenue's way of covering itself and making sure
that taxable income doesn't fall through the net. Miscellaneous income used to
be taxed under Schedule D Case VI. We will consider miscellaneous income in
more detail later in the course.


A1.4 Exempt income

There are a few sources of income which are specifically exempt from income
tax. Income from National Savings Certificates is exempt from tax, as are any
winnings on Premium Bonds. Any income from betting, gaming or lotteries is
exempt from income tax.
s. 692
ITTOIA 2005

Most social security benefits are also exempt from income tax. The notable
exceptions to this are the state pension and any job-seekers allowances. These
are taxable income.
s.660
ITEPA 2003


Introduction to Business Taxation ‘Finance Act 2005’

4

Any statutory redundancy pay received on the termination of an employment is
also exempt from income tax.
s. 309
ITEPA 2003

Scholarship awards are exempt, as is any income from ISAs (individual savings
accounts).
SI 1998/1870


Q

Now test your understanding by attempting the example which follows.


Introduction to the UK Tax System

5
Example 1

Which of the following sources of income are exempt from income tax:

Taxable Exempt
a) Interest on National Savings Account
b) Dividend from a foreign company
c) Child’s wages from a newspaper round
d) Income from National Savings Certificate
e) Housing benefit
f) State retirement pension

Introduction to Business Taxation ‘Finance Act 2005’

6
Answer 1

Taxable Exempt
Interest on National Savings Account


Dividend from a foreign company


Child’s wages from a newspaper round (note)


Income from National Savings Certificates

Housing benefit

State retirement pension


Note:
Wages are taxable as employment income. The fact they are paid to a child is
irrelevant. However, in most instances, the child’s income will be covered by
Personal Allowances so no tax will be due.
Introduction to the UK Tax System

7


SUMMARY - INTRODUCTION TO THE UK TAX SYSTEM


The main taxes in the UK are income tax, VAT, NIC, corporation tax, capital gains tax
and inheritance tax.

Income tax is paid for a tax year which runs from 6 April to 5 April.

Income is categorised into the following sources:

Trading income
Property income - UK
- non-UK
Employment income
Savings and investment income

Foreign income
Miscellaneous income





- interest income
- dividend income

Some income is exempt from income tax such as:

Income from National Savings Certificates
Premium bonds winnings
Income from Betting and Lotteries
Most social security benefits
Statutory redundancy pay
Income from ISAs



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B: Computation of Taxable Trading Profit

B1: TRADING INCOME AND THE BADGES OF TRADE


In this chapter we will look at trading income including:
- the schedule for taxing trading income;
- the definition of a trade;
- the “badges of trade” arising from case law;
- land transactions;
- the anti-avoidance provisions;
- whether receipts are taxable or not.


Statutory references are to ITTOIA 2005 unless stated otherwise.

B1.1 Trading Income

The category “trading income” encompasses both income from a trade, for
example plumbing or building and income from a profession or vocation. A
profession would include accountancy or law. A vocation includes acting, ballet
dancing, theatrical performing, sport etc.

Previously, under the old schedular system income from a trade was taxed under
Schedule D Case I, whereas income from a profession or vocation was taxed
under Schedule D Case II. There were no notable differences between the way
profits were taxed under DI or DII.

B1.2 The definition of trading

Income tax is charged on “the profits of a trade, profession or vocation”.
s. 5

A trade is defined as ”every manufacture, adventure or concern in the nature
of trade”.

A “trade” is defined in the legislation as a “trade”, which is a circular definition
and does not take us a great deal further. Therefore, the interpretation of what
is meant by the term “trade” has been left largely to the Courts. The Courts
have developed a number of tests to determine whether somebody is trading.
These tests are known as the “badges of trade”.

B1.3 The Badges of Trade
Profit seeking motive
When a person enters into a transaction, we need to identify whether there is a
profit seeking motive. It is not the existence of a profit that is important, it is

the motive to earn one. However HM Revenue and Customs (the Revenue) will
really be interested in this issue if a profit has actually been earned, because
then they have something to tax.

Introduction to Business Taxation ‘Finance Act 2005’

10
A taxpayer may argue that they are trading in order to utilise a loss to reduce
their tax bill. The taxpayer must demonstrate the motive rather than the
existence of profit to establish that a trade is being carried on.
Frequency and number of similar transactions
If we do something once, never to be repeated again, it is unlikely that we would
be treated as carrying on a trade. However if we keep doing it, it is more likely
that we are trading. For instance, assume I sold my car which I had owned for
four years. I then bought myself another car and sold that one two years later.
It is unlikely the Revenue would consider that I am trading in cars. If, however,
I bought and sold cars every month, it is more likely that they will seek to tax
the profits as trading income.
The most notable case in this area is
Pickford v Quirke
where a taxpayer
purchased a mill with the object of using it for trading purposes. However it
turned out that the mill was in a much worse state than they had imagined and
the best thing the taxpayer could do was to strip all the items out of it and sell
them piecemeal. He made a considerable profit doing this, so he did it again and
again and again. As a result of the repeated number of transactions, it was
held that the profits were taxable as trading income.
Modification of the asset in order to make it more saleable
If we buy something, do nothing to it then sell it, it is unlikely we are trading.
However, if we bought a car, put a new engine in it, resprayed the body and made

it more attractive to buy, it is possible we would be considered to be trading.
Nature of the asset
We cannot pin a trading label onto a single one-off transaction simply because we
cannot justify that the particular asset was purchased for any other purpose
than to resell it. The most notable case in this area is
Rutledge v CIR
.
In this case, a taxpayer purchased 1 million rolls of toilet paper in one single
transaction. He then sold them on at a profit in another single transaction. This
was held to be trading (an “adventure” in the nature of trade) as there was no
other justifiable reason to purchase such a large quantity of toilet paper - he
could not argue that this was simply overstocking!
Connection with an existing trade
Taking an example of a car, let us say that as a tax accountant I sell a car. It is
unlikely that I would be trading in cars because there is no link between selling
cars and being a tax accountant. If however I was a car mechanic who
occasionally sold a car, the Revenue are much more likely to successfully tax the
profits on the sale of cars along with my existing trade as there is a direct link
between repairing cars and selling cars. Other badges of trade would also need
to apply, but such a link is something that the Revenue will look very closely at.