Part 2 of 4
This is the Finance Act 2013 version of this article. It is relevant for candidates sitting the Paper P6 (UK) exam in 2014. Candidates sitting Paper P6 (UK) in 2015 should refer to the Finance Act 2014 version of this article, to be published on the ACCA website in 2015.
In Part 1 of this article we reviewed the definitions of a group relief group and a capital gains group.
The remaining parts of this article examine the tax planning issues relating to group relief groups. This part looks at companies resident overseas and planning the distribution of losses to members of a group. Throughout this review of tax planning issues, the term ‘losses’ will be used to represent any/all tax attributes that can be surrendered via group relief.
Companies resident overseas are included within a group relief group. However, losses can only be surrendered between companies that are resident in the UK or are resident overseas but have a permanent establishment in the UK. If the H Ltd group were owned by H Inc, a company resident and trading outside the UK and the European Union, rather than H Ltd, the members of the group relief groups would not change. However, losses could only be surrendered between A Ltd and C Ltd and between A Ltd and B Ltd.
The value of a company’s losses depends on how they are used. This value is maximized by offsetting the losses against those profits that would otherwise be taxed at the highest rate of tax. A company will pay tax at the main rate where its augmented profits (taxable total profits plus its franked investment income) exceed the upper limit, at the lower small profits rate where they are less than the lower limit and at a rate in excess of the main rate on those profits between the lower and upper limits. Accordingly, the aim is to offset the losses against:
Most, if not all, students are aware of this strategy – but many misinterpret what it means and think that it is disadvantageous for a company to have profits between the limits. In fact the opposite is true. Companies with profits between the limits pay a rate of tax in excess of the main rate only on the amount of profits between the limits and not on all of their profits. The overall effective rate of tax paid by such companies must, of course, be less than the main rate as the corporation tax liability is computed by charging tax at the main rate and then deducting marginal relief.
The implication of this is that it is beneficial to use losses to cause a company that would otherwise pay tax at the main rate to become a marginal company. This is illustrated in Example 1.
LC Ltd has taxable profits of £425,000 and no franked investment income. Its upper limit is £375,000 and its lower limit is £75,000. It will pay corporation tax on its profits of £97,750 (£425,000 x 23%) because its profits exceed the upper limit. When thinking about the company from the point of view of loss utilization, it can be regarded as paying corporation tax at the following rates.
| £ | ||
|---|---|---|
| On profits up to the lower limit (£75,000 x 20%) | 15,000 | |
| On profits between the limits (£300,000 x 23.75%) | 71,250 | |
| On the remainder (£50,000 x 23%) | 11,500 | |
| Total liability | 97,750 |
A group company is to surrender losses of £150,000 to LC Ltd. This will reduce its profits to £275,000 and cause the company to become a marginal company (a good thing) saving tax partly at the full rate and partly at the marginal rate. The corporation tax liability of LC Ltd will be calculated as follows:
| £ | ||
|---|---|---|
| Corporation tax at the main rate (£275,000 x 23%) | 63,250 | |
| Marginal relief ((£375,000 – £275,000) x 3/400) | (750) | |
| Total liability | 62,500 |
The losses will first relieve the profits taxed at the main rate (£50,000) and then £100,000 of the profits taxed at the marginal rate as set out below.
| £ | ||
|---|---|---|
| On profits above the upper limit (£50,000 x 23%) | 11,500 | |
| On profits between the limits (£100,000 x 23.75%) | 23,750 | |
| Total tax saved (£97,750 – £62,500) | 35,250 |
The effective rate of tax saved in respect of the offset of the losses is 23.5% (£35,250/£150,000); a rate in excess of the full rate, for obvious reasons.
In the exam you should take care to identify the residence status of companies and the location of any permanent establishments as this will affect the planning opportunities available.
Planning the distribution of losses between group members requires a clear understanding of how the rates of corporation tax are applied; make sure you fully understand what is going on in example 1.
Note: Corporation tax issues are considered in two further articles:
Written by a member of the Paper P6 examining team
The comments in this article do not amount to advice on a particular matter and should not be taken as such. No reliance should be placed on the content of this article as the basis of any decision. The author and the ACCA expressly disclaims all liability to any person in respect of any indirect, incidental, consequential or other damages relating to the use of this article.