Groups of companies and overseas aspects

Groups of companies
Associated companies
When answering a question on groups of companies, it is important to identify the number of associated companies in the group. Both the starting rate and small companies rate limits will be divided by the number of associated companies, thus affecting the rate of corporation tax.

Example 1
A Ltd owns 100% of the share capital of B Ltd, C Ltd, D Ltd, E Ltd, F Ltd, and G Ltd. Each of the shareholdings was held throughout the year ended 31 March 2005, with the exceptions that the shareholding in C Ltd was disposed of on 31 December 2004, and the shareholding in D Ltd was acquired on 1 January 2005. E Ltd was a dormant company throughout the year ended 31 March 2005.

1. B Ltd, C Ltd, D Ltd, F Ltd and G Ltd are all under the common control (shareholding of over 50%) of A Ltd, and there are therefore six associated companies in the group.
2. Where a company such as E Ltd has been dormant throughout the accounting period, it does not count as an associated company.
3. Companies that are only associated for part of the accounting period, such as C Ltd and D Ltd, count as associated companies for the whole of the period.
4. The adjusted corporation tax lower and upper limits are £1,667 (10,000/6), £8,333 (50,000/6), £50,000 (300,000/6) and £250,000 (1,500,000/6).

The available reliefs
You should know what reliefs are available to a group of companies, and the relationship that must exist for each relief to be available. There are two types of group relationship:

• the 75% group relationship necessary to claim group relief
• the 75% group relationship necessary for capital gains purposes.

The definition of a 75% subsidiary for capital gains purposes is looser than that for group relief purposes. This is because the required 75% holding need only be met at each level in the group structure.

Example 2
H Ltd is the holding company for a group of companies. The group structure is as follows:

For the year ended 31 March 2005, H Ltd has an unrelieved Schedule D Case I trading loss.

Group relief

1. For group relief purposes, one company must be a 75% subsidiary of the other, or both companies must be 75% subsidiaries of a third company.
2. The holding company must have an effective interest of at least 75% of the subsidiary's ordinary share capital.
3. The holding company must also have the right to receive at least 75% of the subsidiary's distributable profits and net assets on winding up.
4. H Ltd will therefore be able to group relief its trading loss to I Ltd and J Ltd.
5. H Ltd does not have the required 75% shareholding in K Ltd (100% x 80% x 80% = 64%).

Chargeable assets

1. Companies form a capital gains group if at each level in the group structure there is a 75% shareholding.
2. However, the parent company (H Ltd) must have an effective interest of at least 50% in each group company.
3. H Ltd, I Ltd, J Ltd and K Ltd therefore form a capital gains group.

Group Relief
There are two important points to remember with regard to group relief:

• Trading losses can be group relieved against 100% of a 75% subsidiary's profits chargeable to corporation tax, or conversely 100% of a 75% subsidiary's loss can be group relieved. The relief is not restricted to the percentage shareholding
• Only current year losses can be group relieved. No relief is available for trading losses brought forward from previous years.

Where the accounting periods of two group companies are not coterminous, then group relief may be restricted.

Example 3
L Ltd owns 100% of the ordinary share capital of M Ltd. L Ltd has an accounting date of 31 December, and for the years ended 31 December 2003 and 31 December 2004 has profits chargeable to corporation tax of £90,000 and £50,000 respectively. M Ltd has an accounting date of 30 June, and for the year ended 30 June 2004 has a Schedule D Case I trading loss of £70,000.

1. The accounting periods are not coterminous, so both L Ltd's profits chargeable to corporation tax and M Ltd's Schedule D Case I loss must be apportioned on a time basis.
2. For the year ended 31 December 2003 group relief is restricted to £35,000, being the lower of £45,000 (90,000 x 6/12) and £35,000 (70,000 x 6/12).
3. For the year ended 31 December 2004 group relief is restricted to £25,000, being the lower of £25,000 (50,000 x 6/12) and £35,000 (70,000 x 6/12).

The most important factor to be taken into account when considering group relief claims is the rate of corporation tax payable by the claimant companies. Group relief should be surrendered as follows:

• initially to companies subject to corporation tax at the marginal rate of 32.75%
• surrender should then be to those companies subject to the full rate of corporation tax of 30%
• the amount surrendered should be sufficient to bring the claimant company's profits chargeable to corporation tax down to the small company rate limit
• any remaining loss should be surrendered to those companies subject to corporation tax at the rates of 23.75% (marginal starting rate) or 19% (small company rate)
• there is no benefit in surrendering group relief to companies subject to the nil starting rate of corporation tax.

However, the starting rates of corporation tax are unlikely to be relevant in most group relief questions once the limits of £10,000 and £50,000 have been divided between the number of associated companies.

The loss-making group company may of course be able to relieve the loss itself. In this case consideration will also have to be given to the timing of the relief obtained (an earlier claim is generally preferable), and the extent to which relief for Gift Aid donations will be lost.

Example 4
N Ltd has two 100% subsidiaries, O Ltd and P Ltd. The results of each company for the year ended 31 March 2005 are as follows:

As at 31 March 2004 N Ltd had unused Schedule D Case I trading losses of £7,500.

During the year ended 31 March 2005 N Ltd received dividends of £18,000 from O Ltd, and dividends of £9,000 from Q Ltd, an unconnected company.

The corporation tax liability of each of the group companies for the year ended 31 March 2005 is as follows:

1. There are three associated companies in the group, so the relevant lower and upper limits for corporation tax purposes are £100,000 (300,000/3) and £500,000 (1,500,000/3) respectively.
2. N Ltd's trading loss has been relieved so as to reduce both its own and P Ltd's profits down to the lower limit. Note that it is the profit that must be reduced to the relevant limit, and not the profits chargeable to corporation tax.
3. Group dividends are not included as franked investment income.
4. N Ltd's brought forward trading losses of £7,500 are carried forward.

Chargeable assets
It is important to remember that capital losses cannot be group relieved.

Example 5
Why would it be beneficial for all of the eligible companies in a group to transfer chargeable assets to one company prior to the chargeable assets being disposed of outside of the group?

1. By arranging that, wherever possible, chargeable gains and allowable losses arise in the same company this will result in the optimum use being made of capital losses.
2. These can either be offset against chargeable gains of the same period, or carried forward against future chargeable gains.

An asset does not actually have to be moved between companies in order to match capital losses and gains. It is possible for two companies in a capital gains group to make an election so that matching is done on a notional basis.

The election has to be made within two years of the end of the accounting period in which the asset is disposed of outside the group, and will specify which company in the group is treated, for tax purposes, as making the disposal.

The advantages of the election compared to actually transferring an asset between group companies (prior to disposal outside of the group) are:

• the two-year time limit for making an election means that tax planning regarding the set off of capital losses and gains can be done retrospectively
• the two-year time limit also means that it is possible for capital gains to be treated as being made by the company in the group with the lowest rate of corporation tax
• the election can be made in respect of just part of an asset.

Example 6
R Ltd owns 100% of the ordinary share capital of S Ltd. For the year ended 31 March 2005 R Ltd will pay corporation tax at the rate of 30% and S Ltd will pay corporation tax at the rate of 19%.

On 15 August 2004 R Ltd sold an office building, and this resulted in a capital gain of £110,000. On 20 February 2005 S Ltd sold a factory and this resulted in a capital loss of £35,000. As at 31 March 2004 S Ltd had unused capital losses of £40,000.

1. R Ltd and S Ltd must make an election by 31 March 2007.
2. S Ltd's otherwise unused capital loss of £35,000 and brought forward capital losses of £40,000 can be set against the capital gain of £110,000.
3. It is beneficial for the balance of the gain of £35,000 (110,000 - 35,000 - 40,000) to arise in S Ltd as it will only be taxed at the rate of 19%.

Conclusion
With groups of companies it is important to know which reliefs are available to a 75% group. Where a question requires you to calculate the tax position for a group of companies, first establish what group relationships exist, and then plan your answer carefully as regards the reliefs that are to be claimed.

Overseas aspects
Overseas branch compared to an overseas subsidiary
It is important to appreciate the difference between operating overseas through a branch and operating overseas through a subsidiary.

An overseas branch of a UK company is effectively an extension of the UK trade, and 100% of the branch profits are assessed to UK corporation tax. Whether or not profits are remitted to the UK is irrelevant.

Example 7
T Ltd is a UK company with an overseas branch. The results of T Ltd for the year ended 31 March 2005 are as follows:

The overseas branch is subject to tax overseas at the rate of 20%.

The corporation tax liability of T Ltd for the year ended 31 March 2005 is as follows:

1. Double taxation relief is calculated as £40,000 (200,000 at 20%), being the amount of overseas tax paid.
2. This is lower than the UK corporation tax on the branch profits of £57,250 (286,250 x 200,000/1,000,000).

Where operations overseas are conducted through an overseas subsidiary, only dividends paid by the overseas subsidiary to the UK parent company are liable to UK corporation tax. There are a number of factors that have to be considered when deciding whether to operate overseas through either a branch or a subsidiary.

Example 8
U Ltd is a UK company planning to set up an overseas operation. It is unsure whether to operate overseas through a branch or a subsidiary. A subsidiary would remit 50% of its distributable profits to the UK as dividends.

1. Relief is usually available in the UK for trading losses if incurred by an overseas branch, but no UK relief is available for trading losses incurred by an overseas subsidiary.
2. UK capital allowances will be available in respect of plant and machinery purchased by an overseas branch.
3. An overseas subsidiary will be an associated company, and so the UK corporation tax limits will be reduced.
4. A non-UK resident subsidiary will only be assessed to UK corporation tax in respect of dividends remitted to the UK. The full profits of an overseas branch are, however, liable to UK corporation tax in the year that they are made, regardless of whether they are remitted to the UK.

Double taxation relief
The corporation tax liability of a UK company with an overseas branch has already been dealt with. Where an overseas subsidiary is involved, the calculations can be more complicated. You should appreciate the difference between withholding tax and underlying tax in respect of an overseas
dividend.

Example 9
What is the difference between withholding tax and underlying tax in respect of an overseas dividend? What are the conditions that must be met for double taxation relief to be available in each case?

1. Withholding tax is the term used for any overseas tax deducted at source from a dividend payment.
2. Relief for overseas withholding tax is always available.
3. Underlying tax is the term used for the overseas tax paid on the profits of an overseas subsidiary, out of which a dividend is paid.
4. Relief for underlying tax is only given where the UK holding company owns at least 10% of the overseas subsidiary's voting power.

The calculation of underlying relief can cause problems. It is calculated by:

• taking the gross dividend received (before the deduction of withholding tax)
• multiplying by the amount of overseas tax actually paid
• dividing by the post-tax accounting profits (the distributable profits).

Example 10
V Ltd, a UK company, has a 100% owned overseas subsidiary, W Ltd. For the year ended 31 March 2005 V Ltd had a tax adjusted Schedule DI profit of £500,000. The results of W Ltd for the year ended 31 March 2005 are as follows:

W Ltd's actual tax liability was £14,000 higher than the figure provided for in its accounts.

The corporation tax liability of V Ltd for the year ended 31 March 2005 is as follows:

1. V Ltd owns at least 10% of the voting power of W Ltd, and so relief for the underlying tax paid overseas is available.
2. The dividend from W Ltd must be adjusted for the underlying tax suffered overseas.
   

   			£
   Gross dividend			225,000
   Underlying tax
   	(175,000 + 14,000) 189,000
   		225,000 x 525,000	81,000
   Schedule D Case V income			306,000

3. The total overseas tax is £103,500 (22,500 + 81,000).
4. Double taxation relief is restricted to the amount of UK corporation tax on the dividend from W Ltd (306,000 at 30% = £91,800).
5. The corporation tax rate is 30% since V Ltd has one associated company. The relevant upper limit is £750,000 (1,500,000/2).

Where the UK company has trading losses that can be relieved against total profits, or has made Gift Aid donations, then these should initially be allocated against UK income. This will preserve the maximum amount of double taxation relief.

Example 11
Continuing with Example 10, suppose that during the year ended 31 March 2005 V Ltd made Gift Aid donations of £50,000.

1. If the donations were set against Schedule D Case V income, then double taxation relief would be restricted to £76,800 (306,000 - 50,000
   = 256,000 at 30%).
2. V Ltd's corporation tax liability would still be £150,000 (806,000 - 50,000 = 756,000 at 30% = 226,800 - 76,800).
3. If the donations were set against Schedule D Case I income, then V Ltd's corporation tax liability would be reduced to £135,000 (806,000 - 50,000 = 756,000 at 30% = 226,800 - 91,800).

Transfer pricing
The transfer pricing rules prevent UK companies from reducing their profits chargeable to UK corporation tax by, for example, making sales at below market price to an overseas subsidiary, or purchasing goods at above market price from the overseas subsidiary.

Since 1 April 2004 the transfer pricing rules have generally only applied to larger companies, and transactions wholly within the UK have been brought within the scope of the rules. However, any question set on transfer pricing will always involve an overseas company, and it should be assumed that the companies are large enough for the transfer rules to apply.

Example 12
X Ltd, a UK company, is to export goods to its overseas subsidiary company at 30% less than their normal trade-selling price.

1. This will reduce X Ltd's trading profits and hence UK corporation tax.
2. A true market price will therefore be substituted for the transfer price. The market price will be an 'arms length' one that would be charged if the relevant parties were independent of each other.
3. X Ltd will be required to make the adjustment on its self-assessment tax return.

David Harrowven is examiner for Paper 2.3