Introduction to Business Taxation ‘Finance Act 2005’ Introduction to Business Taxation ‘Finance Act 2005’ Chris Jones, BA CTA (Fellow) ATT AMSTERDAM • BOSTON • HEIDELBERG • LONDON • NEW YORK • OXFORD PARIS • SAN DIEGO • SAN FRANCISCO • SINGAPORE • SYDNEY • TOKYO Elsevier Butterworth-Heinemann Linacre House, Jordan Hill, Oxford OX2 8DP 30 Corporate Drive, Burlington, MA 01803 First published 2006 Copyright © 2006, Lexis Nexis UK All rights reserved No part of this publication may be reproduced in any material form (including photocopying or storing in any medium by electronic means and whether or not transiently or incidentally to some other use of this publication) without the written permission of the copyright holder except in accordance with the provisions of the Copyright, Designs and Patents Act 1988 or under the terms of a licence issued by the Copyright Licensing Agency Ltd, 90 Tottenham Court Road, London, England W1T 4LP Applications for the copyright holder’s written permission to reproduce any part of this publication should be addressed to the publisher Permissions may be sought directly from Elsevier’s Science and Technology Rights Department in Oxford, UK: phone: (+44) (0) 1865 843830; fax: (+44) (0) 1865 853333; e-mail: permissions@elsevier.co.uk You may also complete your request on-line via the Elsevier homepage (www.elsevier.com), by selecting ‘Customer Support’ and then ‘Obtaining Permissions’ British Library Cataloguing in Publication Data Library of Congress Cataloguing in Publication Data A catalogue record for this book is available from the Library of Congress ISBN 7506 6938 For information on all Elsevier Butterworth-Heinemann publications visit our website at http://books.elsevier.com Typeset by Integra Software Services Pvt Ltd, Pondicherry, India www.integra-india.com Printed and bound in Great Britian Working together to grow libraries in developing countries www.elsevier.com | www.bookaid.org | www.sabre.org CONTENTS Preface ix CIMA Tax Tables xi A: Introduction to the UK Tax System B: Computation of Taxable Trading Profit B1: Trading Income and the Badges of Trade B2: Adjustment of Profit 17 B3: Capital v Revenue 29 B4: Capital Allowances – Definition 37 B5: Capital Allowances – Computation 45 B6: Industrial Buildings Allowances 57 B7: Intangible Fixed Assets 73 B8: Research and Development Expenditure 79 B9: Tax Law and Accounting Practice 87 C: Taxation of Limited Companies 95 C1: Computation of Corporation Tax 95 C2: Associated Companies 103 C3: Short Accounting Periods 111 C4: Long Periods of Account 117 C5: Corporation Tax Self Assessment (CTSA) 127 C6: Payment of Corporation Tax 139 C7: Interest on Late Paid Tax 147 C8: CTSA Penalty Regime 153 C9: Income from Property 159 C10: Loan Relationships 163 C11: Relief for Trading Losses 171 C12: Relief for Other Losses 181 C13: Corporate Capital Gains 187 C14: Rollover Relief 197 C15: Shares and Securities: Matching Rules 205 C16: Substantial Shareholding Exemption 215 C17: The Principles of Group Relief 221 C18: Group Capital Gains 235 C19: Close Company Definition 247 C20a: Close Company Implications – Part 255 vi Contents C20b: Close Company Implications – Part 261 C21: Investment Companies 267 C22: Corporate Venturing Scheme 273 D: Employee Tax Matters 281 D1: Employed or Self Employed? 281 D2: Introduction to Employment Income & Benefits 289 D3: Company Car & Fuel Benefits 303 D4: Living Accommodation – Taxable Benefits 315 D5: Loans to Employees & Use of Assets 323 D6: Miscellaneous Benefits 331 D7: Expenses of Employment 341 D8: Calculating the Income Tax Liability 351 D9: Introduction to PAYE 359 D10: PAYE End of Year Returns 369 D11: Class National Insurance Contributions 377 D12: Class 1A and 1B National Insurance Contributions 387 D13: Termination Payments 397 D14a: Occupational Pensions & Furbs 409 D14b: The New Pension Regime 415 D14c: The Enterprise Investment Scheme 417 E: Value Added Tax 425 E1: Overview of the VAT System 425 E2: Registration 431 E3: Definition of Supplies 441 E4: Liability of the Supply 445 E5: Schedule VATA 1994 – Zero Rating 449 E6: Schedule VATA 1994 – Exemptions 457 E7: Value of the Supply 461 E8: Deemed Supplies and Self-Supplies 473 E9: Time of Supply 483 E10a: Input Tax: When to Recover 491 E10b: Partial Exemption 495 E11: VAT Records and Returns 513 E12: Accounting for VAT 525 E13: Bad Debt Relief 539 E14: Control Visits, Appeals and Assessments 543 Contents vii E15a: Misdeclaration Penalty 557 E15b: Late Registration Penalty 563 E15c: Default Surcharge 569 E15d: Repeated Misdeclaration Penalty 577 E15e: Other Penalties, Interest and Mitigation 583 E16: Refunds, Repayment Supplement and Interest 595 PREFACE This book provides all the material you need for the CIMA Professional Development Certificate in Business Taxation Within each chapter you will find some examples for you to try, to test you on the important rules covered in the chapter At the end of each chapter, there is a short summary which contains a “pocket digest” of the rules covered within the chapter These individual summaries form a comprehensive overview of the syllabus As this manual has been written specifically to cover all areas of the syllabus we are confident you will find this an invaluable tool leading to success in the examination Other Penalties, Interest and Mitigation 589 To summarise: • Interest will be imposed to provide commercial restitution where tax has been understated on a VAT return • Interest will also be charged where an unregistered person issues an invoice charging VAT • Interest cannot run from a date more than years before the date of assessment/payment • Net errors of £2,000 or less can be corrected by a trader adjusting the VAT account • Net errors exceeding £2,000 require a formal disclosure to Customs and interest will be charged E15e.8 Mitigation Mitigation is basically reduction of a penalty and it is only allowed in respect of certain offences s 70 These offences are: • Tax evasion; conduct involving dishonesty The original penalty for that offence was 100% of the tax evaded • Misdeclaration penalty • Repeated misdeclaration penalty • Late notification of a liability to register results in a VAT penalty • Unauthorised issue of VAT invoices can also result in a penalty Mitigation can be made by Customs or by a VAT appeal body on appeal Customs or the VAT appeal body can reduce the penalty to whatever amount it thinks proper which can even include nil s 60 s.63 s 64 s 67 s 70 A VAT appeal body can reverse any reduction in penalty that was granted by Customs, although this does not happen very often Customs have stated what their policy on mitigation of penalties is in Notice 730 They envisage maximum discounts as follows: • 40% for prompt and accurate disclosure • Up to 25% for full co-operation • 10% for production of documents and attendance of interviews • This leaves a balance of 25% which Customs have said could be mitigated in exceptional circumstances Where Customs have charged a penalty and the trader would like the penalty to be mitigated he will need to provide Customs with good reason Notice 730 590 Introduction to Business Taxation ‘Finance Act 2005’ By law none of the following items can be taken into account when deciding on the mitigation of a penalty by Customs or an appeal body; • An insufficiency of funds to pay the tax due or to pay the penalty • The fact that there has been no loss of tax or no significant loss of tax • The fact that the person liable for the penalty or a person acting on his behalf has acted in good faith Basically some of the major reasons for claiming mitigation are gone, and cannot be considered by Customs when deciding whether to mitigate a penalty or not To conclude if a penalty is charged it may be worth claiming mitigation if the trader feels he has a good case If the trader has been dishonest, hasn’t co-operated, hasn’t produced information then maybe it is not worth asking Other Penalties, Interest and Mitigation 591 Answer Paul will pay a penalty that is the greater of two things; the fixed daily rate penalty or the tax geared penalty Starting with the fixed daily rate penalty with one failure in the previous two years Paul would be looking at a fixed daily rate of £10 per day The return is 55 days late at £10 per day which would give Paul £550 of penalty Alternatively, Paul could be looking at the tax-geared penalty with one failure in the previous two years that would be one-third of 1% of the tax due The tax due is £8,900, a third of 1% of this daily, so for 55 days £1,632 The greater of the two figures is the penalty which Paul will have to pay which comes to £1,632 Answer VAT evasion; Dishonest conduct 5% of VAT due Failure to retain records 100% of the undercharged months late registering for VAT 100% of VAT lost Issuing a VAT invoice when not VAT registered 15% of the VAT due or £50 if greater Certificate of zero-rating issued when property did not qualify for zero-rating £500 VAT 592 Introduction to Business Taxation ‘Finance Act 2005’ Answer The way to approach this sort of question is to look at the output tax and the input tax separately Output tax Input tax £ £ 31.3.06 (4,000) 30.6.06 (1,000) 30.9.06 2,000 31.12.06 4,500 1,000 500 £1,000 output tax payable and £500 input tax repayable means net £500 output tax payable In the return to the end of March the trader has overstated input tax by £4,000 - £4,000 of input tax originally claimed back from Customs which we now owe to Customs It is a negative £4,000 in the input tax column In the return to June the trader has overstated output tax, and paid Customs £1,000 of output tax too much It is a negative figure, but this time in the output tax column In the quarter to September the trader has understated output tax by £2,000, - £2,000 owed to Customs in the output tax column In the return to December the trader has understated the input tax by £4,500 – thus another £4,500 claimed as input tax from Customs in the input tax column In summary, looking at the output tax column, Customs owe the trader £1,000 and the trader owes Customs £2,000 Overall the trader owes £1,000 Looking in the input tax column, the trader owes £4,000, Customs owes the trader £4,500 so overall Customs owe £500 There is £1,000 of output tax payable and £500 of input tax repayable, so the net figure is £500 of output tax payable and because this is £2,000 or less the trader will adjust for it on the next VAT return to be submitted Other Penalties, Interest and Mitigation 593 SUMMARY – OTHER PENALTIES, INTEREST & MITIGATION Customs have a choice of criminal prosecution or a civil penalty when encountering fraud Unauthorised issue of invoices and incorrect certificates of penalties zero rating result in In addition Customs have a whole range of penalties for a whole range of misdemeanours If VAT has not been shown as due on a VAT return and is later collected by assessment, then Customs may charge interest on that unpaid VAT Interest is not charged in cases where it does not represent commercial restitution Interest is calculated on a daily basis from the date the original VAT was due to the date the assessed VAT is paid In practice Customs only assess interest until the date an assessment is actually issued Interest cannot run from a date more than years before the date of the assessment Net errors of £2,000 or less can be corrected by a trader adjusting the VAT account and no interest will be charged Net errors exceeding £2,000 require a formal disclosure to Customs and interest will be charged Mitigation can be given by Customs or by a VAT Tribunal on appeal This Page is Intentionally Left Blank E16: REFUNDS, REPAYMENT SUPPLEMENT AND INTEREST This chapter covers three topics: refunds; repayment supplement; interest E16.1 Introduction This chapter covers four topics; refunds, repayment supplement, interest and security The first three items are roughly connected because they are all to with the situation when VAT is refunded to the taxpayer Security is a different topic and shall be dealt with on its own at the end of the session E16.2 Refunds Refunds of VAT can take two forms; firstly Customs will make a refund of VAT when the output tax is less than the input tax on a VAT return In such a case there will be a negative figure calculated on the VAT return and this figure will be refunded to the trader, usually when the VAT return is submitted s.80 The trader may also get a refund of VAT that he has overpaid at an earlier point in time – an overpayment may have occurred if he incorrectly classified something as standard rated when it should have been zero-rated, etc Thus the VAT he paid over and above the amount due will be refunded to him E16.3 Refund of VAT shown on a VAT return Once a VAT return showing that VAT is repayable to the taxpayer is submitted to Southend the refund due will be automatically dealt with by the VAT Central Unit They will issue instructions to issue a cheque or make a refund payment into a notified Bank account If the time taken to sort out the repayment exceeds the set limit then repayment supplement will be added on to the repayment made s.80 E16.4 Repayment Supplement Repayment supplement is added to a repayment if the Commissioners fail to issue an instruction for a repayment within a 30-day period s.79 Provided certain conditions are met, repayment supplement is the greater of £50 or 5% of the repayment of tax due Notice 700/58/02 596 Introduction to Business Taxation ‘Finance Act 2005’ The 30-day period is not the 30-day period from submitting the return The 30day period begins on the later of two dates; • the day after the last day of the prescribed accounting period to which the claim relates • the date of the receipt of the claim, i.e the day that the VAT return is submitted Certain periods are ignored when calculating that 30-day period The periods left out of account when calculating the 30-day period are those where it is necessary to raise reasonable enquiries or correct errors The period to leave out of the 30 days is defined as beginning when the Commissioners first decide that it is necessary to make enquiries and then ends when they satisfy themselves that they have received complete answers to the questions they raised, or when they decide not to pursue the enquiries any further Any delay on Customs part in acting on that decision is included In practice it is Customs policy not to “stop the clock”, so to speak, until they have notified the trader of an enquiry Repayment supplement is denied if the repayment on the return turns out to be incorrect and thus no repayment supplement will be given to the trader for his repayment The definition of “incorrect” is that the return is overstated by more than the greater of £250 or 5% of the correct repayment In addition to this, no repayment supplement is paid at all if the VAT return in question was submitted late Thus if a trader submits his VAT return on time he will not get any repayment supplement Illustration Joe submits his VAT return for the quarter to 31 December 2005 on 28 January 2006 showing a VAT repayment due of £1,800 Joe is rarely in a repayment situation so Customs decide on February to start an enquiry and they notify Joe of this enquiry on 10 February 2006 After answering a few questions and amending the repayment due from £1,800 down to £1,700, the enquiry is completed on 20 February 2006 But, due to some sort of administrative error, the repayment is not made to Joe until 12 March 2006 Will there be any repayment supplement paid to Joe in addition to the £1,700 repayment? To answer this question the first step is to decide whether the repayment was issued late; late being in excess of the 30-day period Start by looking at the time between the receipt of the return, which was 28 January 2006, and the issue of the repayment order, which was 12 March 2006 which is 42 days Refunds, Repayment Supplement and Interest 597 Initially it looks as if a repayment supplement will be due since 42 days is definitely in excess of 30 days However, there was an enquiry during this period of time and the enquiry period has to be deducted from the 42 days The enquiry period was from 10 February 2006 to the 20 February, which is 11 days long 42 days minus 11 days is 31 days This exceeds the 30-day cut-off point and hence repayment supplement will be due However, the original repayment claim for £1,800 had to be amended and was adjusted downwards by £100 To be entitled to repayment supplement the £100 adjustment needs to be less than the greater of two figures – the greater of £250 or 5% of the correct payment The correct repayment was £1,700, which at 5% gives £85 The greater of £250 and £85 is £250 So, the £100 adjustment needs to be less than £250, which it is By being less than £250, repayment supplement is due which is 5% of the repayment made of £1,700, i.e £85 The repayment paid to Joe will be £1,700 plus £85 One further thing to note about the original 42-day period It is the time between the date the return was received by Customs and the issue of the repayment order Do not include 28 January or 12 March when working out the period A common error is to calculate a period of 44 days by counting the first day (the start date), and the last day (the end date) Those dates are actually ignored When looking at the enquiry period add a start and end date Thus include 10 February and 20 February to get to 11 days Example Alpha Limited submits its VAT return for the quarter to 31 March 2005 on 22 April 2005 The return shows a repayment of £2,500 On May 2005 Customs start an enquiry into the return notifying Alpha Limited of this on May 2005 After a control visit, which discovers no irregularity, the enquiry is closed down on 24 May 2005 Alpha Limited receives its repayment on June 2005 Will repayment supplement also be paid? E16.5 Refund of overpaid VAT A refund of overpaid VAT would occur where a person has paid more VAT to Customs than was originally due For example, a trader has treated certain supplies as standard rated when really they should have been zero-rated On the receipt of the claim, Customs will make a refund of the overpaid VAT to the trader s.80(1) 598 Introduction to Business Taxation ‘Finance Act 2005’ The Commissioners have the power to withhold a refund of VAT if they feel that it would unjustly enrich the claimant The concept of unjust enrichment is quite a difficult one, but as a general rule the repayment cannot unjustly enrich a business if it passes the repayment on to its customers From the Commissioners point of view it is unfair for a business to gain from the sort of windfall that is a refund of VAT s.80(3) There is a restriction where a trader makes the claim for a refund of VAT which he originally paid because he had a mistaken assumption about the way the VAT rules applied In a case like this a refund will only be made to the extent of the loss or the damage which the trader can show he has suffered as a result of the mistaken assumption Otherwise, Customs will allege that any repayment will give unjust enrichment s.80(3A) – (3C) Repayments will be allowed on the basis that they will be repaid to the customer – this will prevent the taxpayer being unjustly enriched and Customs have the power to make regulations for overseeing the reimbursement of traders’ customers where a refund has been made to the trader just for that purpose By the same token, Customs can make regulations to claw back any refund which was supposed to be passed on to the customer but the trader did not this Notice 700/45/02 Customs are not liable to refund tax paid to them more than years before the date of the claim, or years before the date the trader commenced legal proceedings if this is earlier This year limit applies to all claims for input tax, correction of errors, adjustments to take account of a change in the consideration for a supply, pre-registration expenses, post deregistration expenses, adjustments under the Capital Goods Scheme and claims for bad debt relief It is an all encompassing three year limit Following FA 2005 the start date for the three year time limit for claiming refunds in the case of errors on returns or voluntary disclosures or tax accounted for on assessments, is the end of the relevant accounting period In the case of a duplicate payment, it is the date of the payment Example Paul mistakenly charged standard rate VAT on all Widget A supplies made since January 1980 He appealed to a VAT Appeal body on 14 April 2005 that supplies of Widget A should be zero-rated The Appeal body ruled in Paul’s favour on 12 September 2005 A claim was lodged for a VAT refund the next day The refund is restricted to VAT paid from which date? A January 1980 D 14 April 2002 B 14 April 2005 E 12 September 2002 C 12 September 2005 F 13 September 2002 Refunds, Repayment Supplement and Interest 599 E16.6 Interest on overpaid VAT This will be interest that is paid in addition to the overpaid tax being refunded to the trader If a trader has overpaid VAT then there has been a period of time when he has been unable to use his own money because effectively Customs have had his money If this overpayment arose as a result of an error on the part of Customs, then interest can be paid to the trader There are many reasons why VAT might have been overpaid ; maybe too much VAT was paid to Customs in the first place; maybe too little input VAT was reclaimed on a VAT return; or maybe the trader in some way was prevented from recovering VAT at the proper time Interest will be applied to the repayment of VAT and is calculated on a daily basis at fixed rates There is a three-year restriction as seen before Just as overpaid tax is restricted to tax paid in the prior three-year period, similarly interest is restricted to the same three years To claim the interest a trader must make a claim in writing within three years of the end of the period to which it relates Interest is calculated on a daily basis but there are some days that Customs can ignore for the calculation These days are periods of time resulting from an unreasonable delay by the claimant in making the claim, or maybe in providing information so that Customs can establish the claim both in quantity and suitability for repayment s.78 600 Introduction to Business Taxation ‘Finance Act 2005’ Example This is a summary of the chapter so far - fill in the missing words, out of the three options, only one of which is correct Select the correct answer: • Repayment supplement is the greater of £250 / £150/ £50 or 15% / 10% / 5% of the repayment due and is given on repayments of VAT where the VAT return was submitted on time and where a repayment order was not made within 10 / 30 / 60 days • Overpayments of VAT will be refunded provided the claimant will not be unjustly enriched / unfairly gained / unjustly profited • The right to a refund and, if appropriate, interest is limited to VAT paid in the / / years prior to the claim Refunds, Repayment Supplement and Interest 601 Answer Date return submitted (Note 1) Date repayment made 22 April 2005 June 2005 46 days Less: Enquiry notified (Note 2) Enquiry ceased May 2005 24 May 2005 17 days Total (46 – 17) (Note 3) 29 days Repayment not late – no repayment supplement due Note 1: First work out the initial period of time, i.e from the date the return was submitted, which was 22 April 2005, until the date the repayment was made, which was June That is 46 days remembering not to count 22 April or June but rather look at the period in between these dates Note 2: From the 46 day period deduct the enquiry period and that starts when the enquiry was notified to the company, May, until the enquiry ceased on 24 May This time include and 24 May - 17 days Note 3: Total period of time of 46 days minus 17 days is 29 days The repayment effectively was made 29 days late, which is not in excess of 30 days, so it was not made late enough for repayment supplement to be added to it Thus there is no repayment supplement due on top of the repayment for Alpha Limited 602 Introduction to Business Taxation ‘Finance Act 2005’ Answer The correct answer is D years prior to earlier of: Date legal proceedings started 14 April 2005 Date of claim 13 September 2005 14 April 2005 less years = 14 April 2002 The claim is restricted to a three-year period which is the three years prior to the earlier of two dates First is the date legal proceedings were started which in the example was 14 April 2005 The second date is the date of the claim The claim was not lodged until after the Appeal hearing was heard on 13 September 2005 So the earlier of those two dates is 14 April 2005 Go back three years from this date and the claim can be made on VAT charged since 14 April 2002 Answer • Repayment supplement is the greater of £50 or 5% of the repayment due and is given on repayments of VAT where the VAT return was submitted on time and where a repayment order was not made within 30 days • Overpayments of VAT will be refunded provided the claimant will not be unjustly enriched • The right to a refund and, if appropriate, interest is limited to VAT paid in the years prior to the claim Refunds, Repayment Supplement and Interest 603 SUMMARY – REFUNDS, REPAYMENT SUPPLEMENT & INTEREST Refunds of VAT can occur when input tax exceeds output tax on a VAT return On submission of the VAT return, a refund will automatically be made by the VAT Central Unit Repayment supplement will be added to a repayment if Customs failed to issue a repayment instruction within a 30 day period Repayment supplement is the greater of £50 or 5% of the repayment of VAT due VAT will also be refunded if it was overpaid in an earlier period, for example supplies which were treated as standard rated when really they should have been zero rated On receipt of a claim Customs will make a refund of the overpaid VAT to the trader The Commissioners have the power to withhold a refund of VAT if they feel it would unjustly enrich the claimant Where VAT has been overpaid, interest will also be paid in addition to the refund of overpaid tax if the overpayment arose as a result of an error on the part of Customs Interest is restricted to the prior year period and is calculated on a daily basis .. .Introduction to Business Taxation ‘Finance Act 2005’ Introduction to Business Taxation ‘Finance Act 2005’ Chris Jones, BA CTA (Fellow) ATT AMSTERDAM • BOSTON • HEIDELBERG •... an annuity to enable a business to make pension payments to retired staff Revenue 34 Introduction to Business Taxation ‘Finance Act 2005’ Answer Capital Revenue a) Replacement of a photocopier... actually been earned, because then they have something to tax s 10 Introduction to Business Taxation ‘Finance Act 2005’ A taxpayer may argue that they are trading in order to utilise a loss to