Buttercup Ltd is a UK based company engaged in the business of gardening products. The company has been trading for a number of years.
Corporation Tax in the UK is levied on the taxable profits of incorporated businesses (Watterston, 2007). Whilst efforts to simplify the procedure for computation of taxable profits and application of appropriate rates of taxation are being made, the process is complex and requires the consideration of a number of variables in areas of revenues, expenses, allowances, exempt and non-exempt items, reliefs, rates of taxation, and the periods for which incomes are achieved (Watterston, 2007). Corporation tax needs to be approved by parliament every year in order to provide the government with requisite authority to collect it (Watterston, 2007). With the official financial year beginning every year on April 1 and ending on March 31 of the following year, corporation tax rates are determined accordingly for every financial year with the passage of the Finance Act (Watterston, 2007)
Corporation tax is levied on the net profits of incorporated businesses and is absorbed by companies as a direct tax. In the case of Buttercup Ltd, the assignment calls for the calculation of corporation tax for the period April 1, 2009 to March 31, 2010. A number of details have been provided on the company's financial results for the specified period, which accordingly form the basis for the computation of corporation tax. The trading profit of the company is stated to be 790,000 GBP for the specific period. This figure represents the profits earned by the company from its trading operations during the year and forms the starting point of the tax computation process.
The capital allowance for Buttercup Ltd is stated to be 10,000 GBP for the same period. Capital allowances represent tax reliefs that aim to allow the cost of some organisational assets to be written off against taxable profits. Capital allowances are routinely available on costs of (a) plant and machinery used by an organisation for its business, (b) certain building works, and (c) certain research and development expenses (Walton, 2009). Whilst the rate of capital allowance and the method of computing it depend upon the purchased asset, the capital allowance for Butter Cup has been stated at 10,000 GBP. The same figure is used in this computation for writing off against trading profits.
Bank interest received is stated to be 10,000 GBP. Interest received forms part of the taxable income of an organisation and is routinely added to trading or operational income (Williams, 2008). In circumstances where the interest received is net of tax, the gross interest is added to the trading income, and the tax recovered from such income is offset against the amount of calculated tax (Williams, 2008). In the case of Buttercup it is assumed that the interest received is gross in nature and that no deduction has been made from it. The whole amount of 10,000 GBP received by way of interest will thus be added to the trading income.
The Chargeable Gain for Butter Cup from the specified period has been estimated at 38,000 GBP. Chargeable Gains arise if a company or an organisation that is liable for corporation tax sells or disposes of its own assets for more than what it costs (Chargeable Gains… 2010). Chargeable Gains are, in the normal course, liable for corporation tax, and relevant details on its computation need to be included in the company tax return for the period in which the asset was sold or disposed (Chargeable Gains… 2010). Chargeable Gains of 38,000 GBP will thus have to be added to the trading profit for computation of corporation tax.
The dividend received by Butter Cup during the period April 1, 2009 to March 31, 2010 is stated to be 200,000 GBP. Dividends received are not subject to tax in the UK, because such dividends are paid out of post tax profits of other companies. The amount of dividends received will however have to be added to trading income for the purpose of determining of the rate of corporation tax; even though dividends received are not subject to tax.
The computation of taxable profit for determination of the rate of tax for Buttercup is provided as under.
Trading Profit: GBP 790,000
Chargeable Gain: GBP 38,000
Interest Received: GBP 10,000
Dividend Received: GBP 200,000
Capital Allowances: GBP 10,000
Total Taxable Profit for Determination of Tax Rate: GBP 1,028,000
With the tax rate for the income slab GBP 300,001 to GBP 1,500,000 being 28% for the financial year 2009 to 2010, the same will be applicable to Butter Cup. Apart from the basic tax rate @ of 28%, marginal reliefs are provided for the computation of taxes for this profit band, with the use of a marginal divider, (of 400), and a marginal multiplier (of 6) (Hadnum, 2009)
The computation of tax is provided below.
Total Taxable Profit for Determination of Tax Rate: GBP 1,028,000
Dividend Received: GBP 200,000
Taxable Profit: GBP 828,000
Computation of Marginal Relief:
Tax before Marginal Relief @ 28% of GBP 828,000: GBP 231,840
Upper Limit of Taxable Profit Rate: GBP 1,500,000
Deduction of Taxable Profit from Upper Limit:
Upper Limit: GBP 1,500,000
Taxable Profit: GBP 231,840
Balance: GBP 1,268,160
Application of Marginal Divider: GBP 1,268,160 / 400 = GBP 3170
Application of Marginal Multiplier: GBP 3170 x 6 = GBP 19022
Marginal Relief: GBP 19022
Corporation Tax Payable: 231,840 - 19022 = GBP 212818
Corporation tax is normally due within 9 months and 1 day after the end of the accounting period. The corporation tax for Butter Cup must thus be paid by January 1, 2011.
Butter Cup is actively considering the sale of its existing premises in a prime location and moving into smaller premises. Whilst the sale of its existing premises will release money for cash flow purposes, it will open the organisation to liability on account of chargeable gains. Whilst a chargeable gain amount of GBP 38,000 has been provided in the data made available for computation of corporation tax, it is not elaborated whether such gains are expected to arise from the sale of business premises or have taken place otherwise.
Sales of certain types of assets, including business premises, attract additional tax by way of chargeable gains (Watterston, 2007). The chargeable gains computed on sale of such assets is added to the taxable income and taxed at the regular rate of corporation tax applicable to a company (Watterston, 2007). Chargeable gains are basically calculated by determining the amount of money received for an asset and then subjecting such money to deductions on account of (a) the cost of the asset, (b) certain expenses incurred for buying, selling or improving an asset, and (c) for Indexation Allowances. In certain cases chargeable gains can be deferred by the claiming of Business Asset Roll-over Relief on purchase of a new asset in replacement of the sold asset (Chargeable Gains… 2010) (Watterston, 2007).
Whilst the calculation of money received for an asset is normally the amount for which it is sold or disposed, the market value of an asset can also be used for the computation of such money received, in circumstances where the asset was given away, or purposely sold, for an amount that was different from what it was actually worth (Hadnum, 2009) (Watterston, 2007).
Similarly, whilst the cost of an asset is normally computed on the basis of the money paid for it at the time of its purchase or acquisition, different figures might have to be used for this purpose, in circumstances where (a) a part of the asset was sold or disposed, (b) if the asset was a wasting asset, (c) if business asset roll-over relief was claimed on the sale of a previous asset at the time of purchase of this asset, or (d) when the asset was acquired for an amount that did not correspond to its actual worth (Hadnum, 2009) (Chargeable Gains… 2010). Whilst conditions regarding wasting assets do not apply to business premises, the other considerations are valid, from Buttercup's point of view, for computation of chargeable gains (Hadnum, 2009).
Apart from the cost of an asset, UK income tax law also authorises companies to claim deductions for extra money spent on buying, selling or improving the value of an asset. Such deductions can arise because of fees or commissions paid for professional services or advice, Stamp Duty Land Tax and improvement costs (not normal maintenance repair) incurred for increase of asset value (Watterston, 2007).
Indexation Allowance allows companies to claim deduction on account of inflation for the purpose of computing chargeable gains (Watterston, 2007). Whilst the indexation allowance cannot be utilised in loss situations, or to convert a gain into a loss, it can otherwise be used in line with existing rules and applied both to the asset cost and to other allowable acquisition costs (Chargeable Gains… 2010). Such Indexation Allowance can on occasion neutralise the complete amount of chargeable gain (Chargeable Gains… 2010).
Organisations like Buttercup can also claim business asset roll-over relief if they dispose of their existing premises and buy new premises by way of replacement of sold premises (Watterston, 2007). In such cases it may be possible to lessen the new asset cost for purposes of chargeable gains, by the amount of chargeable gains that arises on old asset disposal (Chargeable Gains… 2010). When such new assets are sold or disposed off, the chargeable gain is in such circumstances computed by utilising the costs of the asset, reduced by the rolled over gain (Watterston, 2007). Such a facility allows businesses to roll-over their chargeable gains liability through the purchase of a replacement asset (Watterston, 2007).
Buttercup needs to accordingly look at all these alternatives in order to determine its liability on account of chargeable gains and thereafter make an appropriate decision.
Most businesses, especially if they are small or medium in size, need to make a choice on the business structure of their intended firm (Houghton, 2009). There are two main types of businesses, namely incorporated and unincorporated organisations (Houghton, 2009). Whilst unincorporated business can exist in the form of sole traders or partnerships, incorporated businesses are represented by limited or private limited companies (Limited …, 2010).
Individuals, when operating as sole traders or in partnership with other individuals, trade as individuals or groups of individuals; their liability is individual or joint, as the case may be, and is unlimited for the satisfaction of business debts (Limited …, 2010). Such individuals are taxed under income tax rules (Limited …, 2010). Individuals operating as sole traders are required to register with Inland Revenue within a period of 3 months of commencement of trade and are required to complete and file tax returns for every tax year (Limited …, 2010) (Incorporating…, 2009).
Such individuals, when operating as incorporated firms, work either as employees, or as directors of companies, (which are completely separate entities) (Incorporating…, 2009). The profits of companies are taxed in line with corporation tax rules (Incorporating…, 2009) (Houghton, 2009). The profits from such companies can be extracted by their key people in different ways, like salaries, (on which individuals are expected to pay PAYE and NIC), or dividends (on which individuals need to pay income tax if they are high rate tax payers) (Incorporating…, 2009). A careful assessment of these factors, after taking account of the forecasted earnings (with regard to both amount and stability), and the rates of income and corporation tax, can help individuals in taking decisions regarding the structuring of their businesses (Houghton, 2009).
Whilst the factors elaborated above are important, decisions on business structure need to be made after taking account of a range of other considerations (Incorporating…, 2009) (Limited …, 2010). The rate of corporation tax has historically been significantly lower than that of income tax in the UK (Limited …, 2010). Whilst amendments in taxation law during the last 5 years have led to reduction of such differences between income and corporation tax rates, corporation tax rates continue to be significantly lower, especially for companies in the lower income slab (Limited …, 2010). The corporation tax regime for deductions on purchase of goodwill, costs incurred on research and development, private use of cellular phones, and recovery of CIS deductions to sub contractors, is more generous for limited companies than for sole traders and partnerships (Limited …, 2010). IR 35 issues can also cause problems for individuals who trade through personal service companies, especially in the IT, telecom and knowledge based consultancy segments (Limited …, 2010).
There are a number of other considerations that influence individuals in choosing between unincorporated and incorporated businesses (Houghton, 2009). Some of these are confidentiality of financial and other business information, credibility and image in the market, the need for statutory audits when turnovers exceed GBP 6.5 Million, the additional administration load of limited companies, the need to keep personal and company finances separate, motor and general insurance considerations, and personal mortgage and pension issues (Houghton, 2009).
It is thus best to first analyse each of the factors elaborated above and thereafter assess their individual and collective future implications in order to prepare a composite picture of the advantages and disadvantages of the two alternatives for specific individuals and their unique business situations. Such an exercise will help business owners in arriving at a considered decision on the most appropriate business structure.