This report is aimed at the taxation department of Jolly Baby Ltd. with the aim of providing clarification on a number of key points with regards to Corporation Tax and outlining HMRC's requirements for VAT and PAYE. Tables include edited key points from the Finance Act 2010 in order for employees to gain more in-depth information. Jolly Baby Ltd. recognizes that facts and details here stated are subject to future changes.
Corporation Tax financial year runs from 1 April to the following 31 March, identified by each calendar year. Two rates of Corporation Tax: main rate (28% for FY2010) and small profits rate (21% for FY2010). In future the rate applying to Jolly Baby Ltd. will depend "upon [...] augmented profits for [the specific] period" (Melville 2011, p.132).
Augmented profits are "the sum of [...] chargeable profits and franked investment income (FII)": although FII is not charged to Corporation Tax, the FII to be received by Jolly Baby Ltd. will be considered when determining the tax rate to be paid on chargeable profits (Melville 2011, p.132).
A potential strategy to reduce Jolly Baby Ltd.'s Corporation Tax liability in future would involve subscription "for new ordinary shares in a small unlisted trading company under the terms of the Corporate Venturing Scheme" (Melville 2011, p.138).
Corporation Tax normally paid nine months and one day after the end of the accounting period: interest charged on underpaid tax "from the date on which the tax should have been paid until the date on which it is actually paid"; interest on overpaid Corporation Tax "is calculated at a lower rate than interest on underpaid tax [...] run[ning] from the 'material date' until the date of the repayment" (Melville 2011, p.142).
Jolly Baby Ltd. is required to compute its own Corporation Tax liability: it cannot require HMRC to calculate tax due. Once notified by HMRC Jolly Baby Ltd. is required to file a Corporation Tax return (form CT600) within 12 months of the end of each period of account: late submissions of tax returns; failures to notify HMRC; inaccurate tax returns; failures to keep records and other infringements result in penalty fines (Melville 2011, p.143-144).
As a toy wholesales company Jolly Baby Ltd. is subject to the lower Corporation Tax rate of 21% although there are concerns that this may have to be subsequently altered given the fact that after a few loss-making periods, the extent of this year's net profit per the accounts gives cause for future optimism. The current profit level is not as high as analysts would expect as the aforementioned loss-making periods, a consequence of the recent financial crisis, had a strong effect on sales and revenue with the effects still strongly tangible. This Corporation Tax discrepancy is also explained by the fact that the company has taken advantage of a number of reliefs generally available to firms suffering under business downturn. Under Corporation Tax Act 2010 these reliefs involve carrying the company's losses forward to subsequent years, explaining this year's surprisingly low Corporation Tax liability. As Melville (2011) shows, depending on the growth potential and success of our company, these reliefs to Corporation Tax liability may or may not be available in future.
In accordance with Section 45 and Section 137 of the Corporation Tax Act 2010 there is the possibility for reliefs to be made available should Jolly Baby Ltd. decide to carry its losses forward: these are in respect of general trading losses and are subject to specific rules which are discussed below (HMRC website, accessed 2 March 2010).
Business losses may indeed be carried forward to the equivalent of the losses sustained less any amount of losses already used against profits from previous periods or profits during the current period. Therefore when looking at the total figure of the loss being carried forward all records associated with previous accounting years need to be fully considered.
"Chargeable profits include income and chargeable gains" (Melville 2011, p.89).
Chargeable gains arise should Jolly Baby Ltd. make a "chargeable disposal of a chargeable asset" (e.g. land and buildings, plant and machinery or investments) with the following assets entirely exempt from chargeable gains legislation (e.g. motor cars; items of tangible, movable property (known as 'chattels'); chattels with predicted useful life of up to 50 years unless used by Jolly Baby Ltd. and eligible for capital allowances; "gilt-edged securities and qualifying corporate bonds dealt with by loan relationships regime" (Melville 2011, p.111).
Chargeable disposals occur "when the whole or part of a chargeable asset is sold or given away but gifts of chargeable assets to charity are exempt" (Melville 2011, p.111).
Corporation Tax charged in respect of 'accounting periods' namely "period[s] for which Corporation Tax is charged" with each period beginning when Jolly Baby Ltd. comes within the charge to Corporation Tax (Melville 2011, p.90).
Should a set of Jolly Baby Ltd.'s accounts "cover a period of 12 months or less": this period of accounts will form a single accounting period. Corporation Tax assessment raised for that period (Melville 2011, p.90).
Should a set of Jolly Baby Ltd.'s accounts "cover a period of more than 12 months": this period broken down into two or more accounting periods, each with a separate Corporation Tax assessment (Melville 2011, p.90).
"Trading income consists of trading profit for a set period, adjusted for tax purposes" calculated by taking "the company's pre-tax profit for the relevant period of account" and adjusting it "by excluding non-trading income and adding back disallowed expenses" (Melville 2011, p.92).
During the calculation of Jolly Baby Ltd's trading income it will not be required to "disallow the private proportion of expenses" (Melville 2011, p.92).
Should Jolly Baby Ltd. in future make Gift Aid donations these will be considered as disallowed during the trading income calculation but will then be considered as qualifying charitable donations and deducted during the chargeable profits computation.
"Accounts drawn up in accordance with International Financial Reporting Standards (IFRS) are valid for Corporation Tax purposes" (Melville 2011, p.92)
Accounting periods rank as chargeable periods during the calculation of capital allowances with "one capital allowance computation per accounting period". (Melville 2011, p.93)
During the computation of Jolly Baby Ltd.'s plant and machinery capital allowance, no private use restrictions will be necessary (Melville 2011, p.93).
Should Jolly Baby Ltd. undergo research and development (for toys, baby wear and baby care) expenditure then tax relief on 175% of that amount may be claimed as long as expenses are of a capital nature ("staffing costs, consumables, payments to subcontractors and expenditure on power, fuel and water") and £10,000 of qualifying research incurred in the accounting period (Melville 2011, p.94).
Jolly Baby Ltd. continues to qualify as small or medium-sized until the number of employees exceeds 500 employees and turnover exceeds â‚¬100 million or total assets exceeds â‚¬86 million. (Melville 2011, p.94)
Tax relief given following deduction of 175% of qualifying expenditure during the calculation of Jolly Baby Ltd.'s trading income (Melville 2011, p.94).
Each year in which losses are incurred will necessarily have accounts attached to it with the finality of the loss figures being crucial to the calculation of how these are to be carried forward to subsequent years. It will be necessary to review the accounts from the year prior to the current one in order to determine the final figures recorded in terms of the loss experienced by Jolly Baby Ltd. These figures are of prime importance when taking advantage of reliefs against profits in any given year. As the figures entered in the previous year are deemed final there is no opportunity to question these during the current year. The losses incurred would have included any capital allowances present and these would have reduced the profit level or increased the loss for the year. Furthermore these would not have included any capital gains or losses as these are dealt with separately outside of the Corporation Tax regime. The loss for the year would be included in the Corporation Tax returns figure and be relevant when offsetting any future gains.
It is important to note that this particular figure is carried forward with the trading loss being applied automatically provided that all trading losses are registered in the year in which they are incurred. When reviewing the returns from the year in which a profit is made this may not always be immediately apparent as any losses available to be carried forward are applied automatically (HMRC website, accessed 2 March 2011).
Other issues which may be relevant and have had the effect of reducing the Corporation Tax liability include any capital allowances which may have been applied against this company's assets: these should be noted in the Corporation Tax returns. In this case the trading losses from previous years have been automatically applied during the current year - during which a profit was made - in order to reduce the overall tax liability.
Interest payable on loans taken out by Jolly Baby Ltd. to buy or improve let property is disallowed in the calculation of property income (Melville 2011, p.95).
Should Jolly Baby Ltd. "receive interest net of income tax" then it may be possible for the income tax to be "deducted at source and then assessed on the gross amount of interest accrued in the accounting period" (Melville 2011, p.99).
"Dividends received from other UK companies are paid out of profits already subject to Corporation Tax: to avoid double taxation these dividends are not included in the chargeable profits" (Melville 2011, p.101).
Should Jolly Baby Ltd. make certain charitable donations and gifts these would be referred to as 'qualifying charitable donations' and deductible during the calculation of chargeable profits (Melville 2011, p.101).
"Interest payable on underpaid Corporation Tax is treated as a non-trading debit" (Melville 2011, p.102).
The loss reliefs available to Jolly Baby Ltd. "involve either carrying the loss forward against future trading profits or setting the loss against the company's total profits for a specified period": "rules granting tax relief in relation to trading losses are located" in the Corporation Tax Act 2010 (Melville 2011, p.147).
"Carry forward of trade loss relief involves a trading loss carried forward and set against future profits of the same trade": takes effect if no other tax relief "is claimed in relation to trading loss" (Melville 2011, p.148).
Trading loss incurred in 12 months before trade ceases may be set against total profits of proceeding three years (Melville 2011, p.148).
Should Jolly Baby Ltd. claim any other form of loss relief in relation to a trading loss then the loss would be "carried forward and relieved against the company's future trading profits" (Melville 2011, p.148):
Charitable donations made by Jolly Baby Ltd. which cannot be relieved against in the accounting period in which they are paid are lost and cannot be carried forwards or backwards for relief in subsequent or previous accounting periods (Melville 2011, p.158-159).
"If a trading loss has been set against total profits of the loss-making period and part of the loss remains unrelieved, this part of the loss may be set against the total profits of the previous 12 months" (Melville 2011, p.158-159).
Should claims to relieve trading losses against total profits result in a repayment of Corporation Tax for an earlier accounting period then this repayment will attract interest (Melville 2011, p.158-159).
VALUE ADDED TAX (VAT)
There are two areas of concern raised in regards to Value Added Tax (VAT): the first point involves the fact that following the review of VAT returns some of the VAT payments made to HMRC are not reconcilable with the level of sales. Although this company supplies goods at the standard rate of tax there are certain items which have a reduced or zero rate tax. Should items be deemed to be a reduced rate VAT product, they only incur VAT at 5% whereas if they are zero rated they incur VAT at 0%.
Although we are not a large company to date this firms sells a number of products particularly geared to the baby/young child market. As stated in VAT Notice 714 all baby wear and childrenswear is zero rated therefore incurring a nought percent VAT level. Other items such as child car seats are at a reduced rate of 5% which may explain the supposed discrepancy between the level of sales and the amount of VAT actually paid.
"A taxable supply is any supply of goods or services other than an exempt supply and may be charged to Value Added Tax at either the standard rate, the reduced rate or the zero rate"(Melville 2011, p.176).
"The VAT system is administered by HM Revenue and Customs. Penalties are imposed for non-compliance with VAT regulations" such as: criminal fraud; notification failures, incorrect VAT returns, default surcharges, VAT wrongdoings and breaches of regulation; however certain penalties can be mitigated if there is a reasonable excuse or if the company "has voluntarily disclosed any non-compliance and has co-operated fully with HMRC". (Melville 2011, p.197).
Eligible businesses registered for VAT may opt to join the flat-rate scheme (FRS) for small businesses, enabling VAT liability to be calculated "as a flat-rate percentage of total turnover" avoiding the need for detailed records of input tax and output tax to be kept (Melville 2011, p.182-183).
Specific guidance is offered by HMRC in terms of the types of records to be filed when undergoing VAT accounting (HMRC website, accessed 2 March 2011). As well as keeping specific records associated with VAT, there is also a requirement to maintain a separate VAT account. HMRC does not prescribe the exact way in which records of account should be maintained and these are adapted in order to deal with specific business needs. It is imperative that these are complete, reliable and open to inspection. The records maintained need to be sufficiently detailed to allow individuals to calculate correctly the VAT amounts owed to HMRC or to be reclaimed by HMRC in future (James 2009). For example, the types of records which HMRC expect to see include: income statements, bank statements, cash books and other material indicating the level of orders and deliveries, together with purchase books and any business correspondence which proves the VAT paid to Jolly Baby Ltd. or by Jolly Baby Ltd.
It will also be necessary for Jolly Baby Ltd. to keep records of all goods and services sold on the standard, reduced, zero or exempted rates in order for these to be easily identified during the undergoing of calculations. Where appropriate it may be necessary to keep records of all credit notes and debit notes issued as these may have a substantial impact on the final VAT figures. Essentially the critical factor is whether or not the accounts are enough to allow Jolly Baby Ltd. to identify exactly the amount of VAT which is owed or owing.
FLAT RATE SCHEME
Flat rate scheme operates as follows (Melville 2011, p.182-183):
"Output tax charged to customers at normal rate for the supply: input tax paid to suppliers at the normal rate"; "output tax charged to customers is not paid over to HMRC and (in general) input tax cannot be recovered" (Melville 2011, p.182-183).
In each tax period "a flat-rate percentage is applied to the VAT-inclusive turnover for the period" (including the value of any exempt supplies): this results in "the amount of VAT payable to HMRC for the period" (Melville 2011, p.182-183).
Given that the standard rate is now 20%, the applicable flat-percentage for Jolly Baby Ltd. will range from 4% to 14.5% (Melville 2011, p.182-183).
Input tax on purchases of capital assets costing at least £2,000 (including VAT) can be reclaimed in the usual way, in which case "output tax must be accounted for [â€¦] on the eventual disposal of the asset" (Melville 2011, p.182-183).
As an employer it is necessary for Jolly Baby Ltd. to administer the Pay As You Earn (PAYE) regime in order to comply with the requirements set out by HMRC. The process of PAYE is used in order to collect both Income Tax and National Insurance contributions from employees in order for these amounts to be paid at the time at which they are actually earned. Based on this Jolly Baby Ltd. is obligated to collect these amounts prior to paying employees and to then pay these amounts to HMRC on either a monthly or quarterly basis depending on the volume. Annual accounts also need to be filed detailing the PAYE which has been collected and paid; however this is not a consideration at this time of year.
It is necessary for employers to whom PAYE may apply to register with HMRC. This can now be done online allowing the filing of all records to be completed either online or on paper.
The main form used throughout the year, on an ongoing basis, is that of the P11: this is used to record information in relation to what an employee earns and any PAYE deductions made from the PAYE. These forms are not only used as a means of calculating the amount of PAYE to be deducted but are also used to form the basis of the returns made to HMRC on a monthly or quarterly basis. These are also used to create the end of year form P14.
Deducting the PAYE is Jolly Baby Ltd.'s responsibility and any failure to do so will render Jolly Baby Ltd. liable to pay any unpaid PAYE which is not collected along with a number of fines for any delayed payments.
Should Jolly Baby Ltd. employees require further information they are advised to access the UK Legislation website - available at www.legislation.gov.uk - and the HMRC website - available at www.hmrc.co.uk - as both websites provide a comprehensive overview of all business-related tax issues.