The finance director of Achiote Ltd would like your advice on the tax implications of the acquisition of two intangible fixed assets, various transactions involving an overseas subsidiary, and opting to tax a commercial building.
Achiote Ltd:
– Owns 100% of the ordinary shares in Borage Ltd and 80% of the ordinary shares in Caraway Inc.
– Achiote Ltd and Borage Ltd are resident in the UK. Caraway Inc is resident in the country of Nuxabar.
– All three companies are trading companies and prepare accounts to 31 March annually.
Borage Ltd – purchase of intangible fixed assets:
– Borage Ltd purchased the goodwill of an unincorporated business for £62,000 on 1 September 2016.
– Borage Ltd will amortise this goodwill in its accounts on a straight-line basis over a five-year period.
– Borage Ltd also purchased a patent from Achiote Ltd for £45,000 on 1 January 2017.
– Achiote Ltd had purchased the patent for £38,000 on 1 January 2014.
– The patent was being amortised in Achiote Ltd’s accounts on a straight-line basis over a ten-year period.
– Borage Ltd will continue to amortise the patent over the remainder of its ten-year life.
Achiote Ltd – loan to Caraway Inc:
– Achiote Ltd made a loan of £100,000 to Caraway Inc on 1 April 2016.
– The rate of interest on the loan is 6% per annum, which is 2% below the rate applicable to an equivalent loan from an unrelated party.
– There is no double tax treaty between the UK and Nuxabar
Achiote Ltd – sale of equipment to, and proposed sale of shares in, Caraway Inc:
– Achiote Ltd acquired its 80% shareholding in Caraway Inc on 1 January 2017 for £258,000.
– Achiote Ltd is now proposing to sell an 8% shareholding in Caraway Inc to an unconnected company on 1 October 2017 for £66,000.
– An item of equipment owned by Achiote Ltd and used in its trade was sold to Caraway Inc on 1 March 2017 for its market value of £21,000.
– The item of equipment had cost Achiote Ltd £32,000 in May 2016.
Achiote Ltd – purchase and rental of a commercial building:
– Achiote Ltd has recently purchased a two-year-old commercial building from an unconnected vendor.
– The building will be rented to an unconnected company, Rye Ltd.
– Rye Ltd is a small local company, which supplies goods to Achiote Ltd but does not charge value added tax (VAT) on these sales.
Required:
Explain, with supporting calculations where appropriate, the corporation tax treatment in the year ended 31 March 2017, of the goodwill and the patent acquired by Borage Ltd.
Achiote Ltd, Borage Ltd and Caraway Ltd
Goodwill
No amortisation in respect of goodwill is deductible for corporation tax purposes, so the amortisation charged in the accounts for the year ended 31 March 2017 must be added back for tax purposes.
Patent
As the patent is transferred between two members of a capital gains group, it will be transferred at a price which is tax neutral. The written down value of the patent in Achiote Ltd at the date of its sale to Borage Ltd was £26,600 (£38,000 – (3 x 10% x £38,000)). Accordingly this will be the deemed acquisition price for Borage Ltd. Borage Ltd will continue to amortise the patent over the remainder of its ten-year life. In the year ended 31 March 2017 amortisation charged in its accounts will be £950 (£26,600/7 x 3/12). This amount is allowable for corporation tax purposes.
Explain the implications of the rate of interest charged by Achiote Ltd on the loan to Caraway Inc by reference to the transfer pricing legislation, and any action which should be taken by Achiote Ltd.
Loan to Caraway Inc
It would appear that an arm’s length rate of interest on the loan would be 8% as this is the rate at which Caraway Inc could have obtained an equivalent loan from an unrelated party. As Achiote Ltd controls Caraway Inc, they are connected companies and so the transfer pricing rules apply.
The interest receivable by Achiote Ltd is £2,000 (£100,000 x 2%) less than it would be under an arm’s length agreement. This means that Achiote Ltd’s non-trading loan relationship income is reduced by this amount, such that less tax is payable in the UK. Therefore, Achiote Ltd must adjust the figures within its corporation tax return to reflect the arm’s length price.
As there is no double tax treaty between the UK and Nuxabar, Nuxabar will be regarded as a non-qualifying territory. As a result, the exemption which might otherwise have been available if a group is not large will not be available to the Achiote Ltd group.
Achiote Ltd can seek advance approval from HM Revenue and Customs in respect of any intra-group pricing arrangements, including the rate of interest to be charged on a loan.
Advise Achiote Ltd of the chargeable gains implications arising from (1) the sale of the item of equipment to Caraway Inc; and (2) its proposed sale of the shares in Caraway Inc.
Transfer of the item of equipment and the sale of shares in Caraway Inc
Sale of item of equipment
The intra-group transfer of the item of equipment by Achiote Ltd to Caraway Inc will not be treated as a no gain, no loss transfer, because even though Achiote Ltd owns 80% of the company, such that the companies are in a capital gains group, the fact that Caraway Inc is not a UK resident company means that the asset will no longer be within the charge to UK taxation. This is therefore a chargeable disposal for Achiote Ltd at 1 March 2017. Although the equipment has fallen in value, no capital loss will arise as the asset qualified for capital allowances as it was used in Achiote Ltd’s trade.
Sale of shares in Caraway Inc
The sale of the 8% holding in Caraway Inc will not be exempt from corporation tax under the substantial shareholding exemption (SSE) rules. This is because Achiote Ltd will only have held its shares in Caraway Inc for nine months prior to the proposed disposal date and so will not meet the criteria to have owned at least 10% of the shares in Caraway Inc for a continuous 12-month period out of the two years prior to disposal. Accordingly, a chargeable gain will arise on the disposal, calculated as follows:
(i) On the assumption that Rye Ltd makes only taxable supplies, state TWO legitimate reasons why it might not charge value added tax (VAT) on its sales to Achiote Ltd.
(ii) Explain whether or not it would be financially beneficial for Achiote Ltd to opt to tax the commercial building, and the implications for Rye Ltd if it chooses to do so.
Note: The following indexation factors should be used for this question, where applicable:
January 2014 to January 2017 0·067
May 2016 to March 2017 0·038
January 2017 to October 2017 0·033
March 2017 to October 2017 0·026
(i) Reasons why Rye Ltd might not charge value added tax (VAT) on its sales to Achiote Ltd
Rye Ltd is a small company, and its taxable supplies may not yet have reached the registration threshold.
Rye Ltd’s taxable supplies have reached the registration threshold, but its supplies to Achiote Ltd are zero rated.
(ii) Option to tax the commercial building
As the building purchased by Achiote Ltd was less than three years old, and a commercial building, it would have been a standard-rated supply. So Achiote Ltd will have incurred a significant amount of input value added tax (VAT) in relation to this expenditure. For this reason, it will be financially beneficial (at least in the short term), for Achiote Ltd to opt to tax the building in order to be able to reclaim this tax. This will also enable Achiote Ltd to recover the input tax in respect of the building’s running costs.
However, VAT must then be added to the rent charged by Achiote Ltd to Rye Ltd. The impact of this on Rye Ltd will depend on its size and the nature of its supplies.
– If its taxable supplies are currently below the registration limit, Rye Ltd could voluntarily register for VAT purposes and reclaim the input VAT charged on the rent payments.
– If Rye Ltd’s taxable supplies have reached the registration threshold, but its supplies are wholly or partially zero rated, provided it has registered for VAT purposes, the input VAT charged on the rent payments will, again, be reclaimable, and may lead to a (higher) repayment of VAT from HM Revenue and Customs.
Tutorial note: In order to determine whether or not opting to tax the commercial building would be commercially beneficial, longer term implications, such as the impact on the building’s future marketability, would also need to be considered. Credit was also available for candidates who made reference to partial exemption.