This article is written to assist candidates in approaching and succeeding in Question 2 of the Foundations in Taxation (FTX) (UK) exam. It is relevant to those of you taking Paper FTX (UK) exam in either June or December 2015 or June 2016, and is based on tax legislation as it applies to the tax year 2014–15 (Finance Act 2014). It will cover the common areas of corporation tax and will highlight the common errors and pitfalls made by those taking the exam. It will not cover any area outside of the Paper FTX (UK) syllabus.
Question 2 of the FTX (UK) exam is always a 15-mark corporation tax question. It will normally require candidates to compute the corporation tax payable by a UK-registered company based on given information. Much of the information given will be standard detail that most UK companies will have to deal with in every accounting period.
The first problem is that some candidates confuse a company assessment with that of an individual. This may be due to exam pressure; however, the question will always make it clear that it is a company (plc or Ltd) – there should never be a doubt. When doing a company assessment, all income and gains are assessed in one total column; the breakdown of income into the three categories of non-savings, savings and dividend relates to individuals only, never companies. On a similar note, companies do not get personal allowances or the annual exempt amount for chargeable gains.
The first entry in the assessment is always the trading income. This figure comes from the trading activities of a company and may be given as ‘adjusted’ or ‘unadjusted’. It is vital that candidates ensure that they check whether the figure given in the question is before or after adjustments – often candidates adjust the figure given when it does not require adjusting.
When the term ‘trading profits after the deduction of…’ is used, then this indicates that the profit figure needs adjusting to arrive at the taxable trading income. Whereas when the terms ‘trading income’ or ‘adjusted trading profits’ are used, then this indicates that no adjustment to the figure is required. Occasionally, the question will state ‘adjusted trading profit before interest and capital allowances’ – this term means that the profit has been partially adjusted but will need further adjustment for the interest and capital allowances given.
If capital allowances are not already deducted from the trading income figure in the question, then these must be deducted from the trading profit and not from any other income. If they are deducted elsewhere in the assessment no mark will be awarded for the deduction.
If the question contains detail of a trading loss brought forward from a previous period, then this loss must be deducted from the trading income figure (after capital allowances), and nowhere else in the assessment. Once again, failure to deduct the figure in the correct place will result in no mark being awarded.
Candidates must decide whether the interest figures given are for trade purposes or for non-trade purposes. In the Paper FTX (UK) exam all interest received should be treated as non-trade. Interest payable, however, may be either. Either the question will state that the interest paid is trade or non-trade, or it will give enough information to enable the candidate to make the correct decision.
If the interest payable is trade interest, then it must be deducted in the calculation of trading income. Non-trade interest payable, however, must be pooled with interest received to give one net figure. This is then included in the corporation tax assessment as ‘interest income’. Failure to net the figures together will result in a failure to gain marks.
The netting of interest receipts and payments will not, in the Paper FTX (UK) exam, ever result in a deficit, as this area is outside the syllabus.
Both trade interest and non-trade interest must be calculated on the accruals basis. Candidates must check the information given and calculate the correct amount to be included in the chargeable period given in the question.
Companies pay and receive interest gross to/from other UK companies or UK banks and, therefore, the figures given in the question will not need grossing up. Many candidates mistakenly gross up all interest by 100/80. Only that income paid or received to/from individuals will need grossing up. The question will clearly state if interest is paid or received to/from individuals – if the question does not say, then candidates should assume it is from another UK company and should not, therefore, gross up the interest.
Property business income
This includes all income from rental properties. It must be calculated on the accruals basis and, therefore, candidates should ensure that they include any rent outstanding for the period – the actual date of payment is irrelevant, it is taxed in the period that it is due. The calculation is identical to that for individuals with the exception that interest payable is not a deductible expense, but is treated as non-trade interest as described in the previous paragraphs. In addition, the wear and tear allowance on furnished lettings is not available to corporate landlords.
If the calculation results in a property loss, then that loss must be deducted in the same year against the total profits before qualifying charitable donations. If all of the loss cannot be used in this manner, then it can be carried forward to the following year and used against total profits before qualifying charitable donations. If the loss is deducted in the wrong place – for example, against next year’s property business income – then full marks will not be given.
Chargeable gains of a company are treated like any other income of a company and are included in the corporation tax assessment – companies do not pay capital gains tax. The question will normally give the actual amount of the chargeable gain but may sometimes require the candidate to calculate the figure (see below). All gains must be aggregated. If capital losses are given, either for the same period or carried forward from an earlier period, then these losses must be deducted from the aggregated gains to give a net chargeable gain figure. Once again, if capital losses are deducted in the wrong place, full marks cannot be awarded. Candidates should note that companies are not entitled to the annual exempt amount.
Qualifying charitable donations
Donations made by a company to a charity in the Paper FTX (UK) exam are always to be treated as qualifying charitable donations unless they are small amounts to a local charity, in which case they should be included as a deduction from the trading income figure. Donations are always made gross and, therefore, candidates should not gross the payment up as they would for an individual. The payment must be deducted from total profits (after current year trade and property business losses); they should not be deducted elsewhere in the assessment otherwise full marks cannot be awarded.
Taxable total profits (TTP)
This is the term used for the total of all of a company’s income and gains less qualifying charitable donations. This figure is the figure that the relevant tax rate will be applied to.
Dividends payable are not allowable deductions and should always be ignored when calculating TTP. Dividends received are not taxable; however, dividends received from non-associated companies (see below) are grossed up by 100/90 and called franked investment income (FII) before being added to the taxable total profits to give augmented profits.
Augmented profits (AP)
This figure determines the rate of corporation tax. However, the rate of tax is never applied to this amount. Candidates must always calculate the AP to determine the rate of tax but be careful to then apply the rate to the TTP.
The tax limits are given in the tax tables included in Paper FTX (UK) exam. If a company’s AP are £1,500,000 or above, then the main rate of tax (21%) is applied to the TTP to give the tax payable. If the AP are £300,000 or less, then the small profits rate of tax (20%) is applied to the TTP. Where AP are between the two limits, then the main rate is applied to the TTP and then marginal relief is deducted. The marginal relief formula is always given in the tax tables supplied in the Paper FTX (UK) exam. Candidates should note that you never used the marginal relief deduction when the small profits rate of tax is used.
Adjustment of tax limits
Before the rate of tax is determined the tax limits may have to be adjusted. They are adjusted for two reasons:
- Where the chargeable period is less than 12 months the limits should be reduced to reflect the length of the period – for instance, an eight month period will result in limits of £1,000,000 (£1,500,000 x 8/12) and £200,000 (£300,000 x 8/12).
- If a company has associated companies, then the two tax limits are divided equally between all companies in the ‘associated group’ – for instance, if a company has two associated companies, then both the tax limits are divided by three to give each company limits of £500,000 and £100,000.
Candidates should take care in checking for both situations. A company with two associated companies and an eight month chargeable period will have limits of £333,333 (£1,500,000/3 x 8/12) and £66,667 (£300,000/3 x 8/12). Candidates are reminded to check both of these situations before determining which rate of tax to apply.
Candidates must not confuse the taxation definition of an associated company with the accounting definition. For tax purposes a company is associated with another if it is controlled by that company or both are under the control of the same person or persons (this may be a company or individual). Control here means holding over 50% of the share capital or voting power or being entitled to over 50% of the distributable profits or the net assets on a winding up. The exam question will always make it clear if there is an associated company, but candidates must be aware this may be by stating that a company holds various holdings of shares in different companies – only those where the holdings are over 50% will be classed as associated companies.
A typical question may say that A Ltd holds 70% of the shares in S Ltd and 40% of the shares in T Ltd. If this is so, then only S Ltd is an associated company and the tax limits would therefore be divided by two. Note that dividends received from S Ltd would be ignored for all tax purposes, but dividends from T Ltd would be grossed up by 100/90 and included as FII when calculating A Ltd’s AP.
As mentioned above, the figures for chargeable gains and losses will usually be given in the question. On occasion, however, the question may require the candidate to calculate the chargeable gain. In a typical question this calculation will be a basic gain – technical calculations will be examined in a separate chargeable gains question. Candidates are reminded that companies get a deduction for inflation, called the indexation allowance, in calculating chargeable gains. Indexation factors will always be given – not retail price indexes.
A Ltd sold a factory in December 2014 for £350,000, which had cost the company £100,000 in May 2002 and had been improved at a cost of £30,000 in June 2003.
Indexation factors are:
May 2002 to December 2014: 0.350 and June 2003 to December 2014: 0.331.
The resulting gain would then be: