Cinnabar Ltd requires advice on the corporation tax treatment of expenditure on research and development, the sale of an intangible asset, and a proposed sale of shares. Cinnabar Ltd has also requested advice on the potential to claim relief for losses incurred in a new joint venture.
Cinnabar Ltd:
– Is a UK resident trading company.
– Has one wholly-owned UK subsidiary, Lapis Ltd.
– Is a small enterprise for the purposes of research and development expenditure.
– Prepares accounts to 31 March each year.
– Expects to pay corporation tax at the main rate for all relevant accounting periods.
– Intends to enter into a joint venture with another UK company, Amber Ltd. This joint venture will be undertaken by a newly incorporated company, Beryl Ltd.
Research and development expenditure – year ended 31 March 2015:
– The expenditure on research and development activities was made up as follows:
(i) Explain, with supporting calculations, the treatment for corporation tax purposes of the items included in Cinnabar Ltd’s research and development expenditure for the year ended 31 March 2015.
(ii) Explain the corporation tax implications for Cinnabar Ltd of the sale of the intangible asset to Lapis Ltd.
Cinnabar Ltd
(i) Research and development expenditure
The computer hardware qualifies for a 100% capital allowance as capital expenditure on an asset related to research and development.
As Cinnabar Ltd is a small enterprise for research and development purposes, the revenue expenditure which is directly related to undertaking research and development activities qualifies for an additional 125% deduction in calculating its taxable trading income. This additional deduction applies to the software and consumables and the staff costs. However, as the external contractor is provided by an unconnected company, only £6,500 (65% of the £10,000 fee) will qualify for this additional deduction.
The rent payable is not a qualifying category of expense, so is not eligible for the additional deduction.
The total deduction from taxable trading profit for the year ended 31 March 2015 is therefore £416,125 (£228,000 + 125% x £(18,000 + 126,000 + 6,500)).
(ii) Intra-group transfer of an intangible asset
As Cinnabar Ltd owns more than 75% of Lapis Ltd, the intangible asset will be treated for corporation tax purposes as having been transferred intra group at its tax written down value, thereby giving rise to neither profit nor loss in Cinnabar Ltd’s corporation tax computation.
Calculate the after-tax proceeds which would be received on the proposed sale of the Garnet Ltd shares on 30 November 2015 and explain the potential advantage of bringing forward this sale to October 2015.
Note: The following indexation factor should be used where necessary:
July 2009 to November 2015 – 0·1903
Disposal of Garnet Ltd shares
A chargeable gain will arise on the proposed disposal in November 2015, calculated as follows:
Explain, with supporting calculations, the extent to which Cinnabar Ltd can claim relief for Beryl Ltd’s trading loss under each of the proposed alternative capital structures.
Loss relief implications of the alternative structures
Structure 1:
Under this structure, Amber Ltd will own more than 75% of the shares in Beryl Ltd, so Beryl Ltd will be in a group with Amber Ltd for the purposes of group relief for trading losses. Accordingly, none of Beryl Ltd’s trading loss will be available for surrender to Cinnabar Ltd.
Structure 2:
Under this structure, Beryl Ltd will be a consortium-owned company, with Amber Ltd and Cinnabar Ltd as the consortium members. This is because each of the companies owns at least 5% of the shares in Beryl Ltd, and together they hold at least 75% of the shares.
Beryl Ltd’s trading loss for the year ending 31 December 2016 may be surrendered to the consortium members according to their respective shareholdings. Cinnabar Ltd may therefore claim a maximum of £19,200 (24% of Beryl Ltd’s loss of £80,000) in respect of this year. Relief will be taken against Cinnabar Ltd’s taxable total profits for the corresponding accounting period(s).
As Cinnabar Ltd prepares accounts to 31 March annually, the maximum loss which can be claimed for relief in the year ending 31 March 2016 will be the lower of £4,800 (3/12ths of the available loss of £19,200) and 3/12ths of Cinnabar Ltd’s taxable total profit for the year ending 31 March 2016. Similarly, the maximum loss which can be claimed for relief in the year ending 31 March 2017 is the lower of £14,400 (9/12ths of £19,200) and 9/12ths of Cinnabar Ltd’s taxable total profit for the year ending 31 March 2017.
Cinnabar Ltd expects to pay corporation tax at the main rate, so as it has one associated company (Lapis Ltd), its taxable total profit must exceed the upper limit of £750,000 (£1,500,000/2). Therefore, the loss relief must be the lower figure for each 12-month period, which will be £4,800 in the year ending 31 March 2016 and £14,400 in the year ending 31 March 2017.