Your manager has received a letter from Christina. Christina is the managing director of Sprint Ltd and owns the whole of that company’s ordinary share capital. Sprint Ltd is a client of your firm. Extracts from the letter from Christina and an email from your manager are set out below.
Extract from the letter from Christina
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I intend to purchase the whole of the ordinary share capital of Iron Ltd on 1 November 2015. My company, Sprint Ltd, purchases components from Iron Ltd, so the two companies will fit together well. I hope to increase the value of Iron Ltd over the next three to five years and then to sell it at a profit. I need your advice on the following matters: Corporation tax payable Iron Ltd has not been managed particularly well. It has had significant bad debts and, as a result, is in need of more cash. To help determine its financial requirements, I need to know how much corporation tax Iron Ltd will have to pay in respect of its results for the 16-month period ending 30 June 2016. Iron Ltd’s tax adjusted trading income for this period is budgeted to be only £30,000. In fact, if we discover further problems, it is quite possible that Iron Ltd will make a trading loss for this period; but please base your calculations on the budgeted profit figure of £30,000. Iron Ltd has no income other than trading income. Following the acquisition, Iron Ltd will sell a small industrial building for £160,000 and an item of fixed machinery for £14,000 on 1 December 2015. The industrial building and the item of fixed machinery were both purchased on 1 June 2012 for £100,000 and £13,500 respectively. At that time, rollover relief of £31,800 was claimed against the acquisition of the industrial building and £3,200 against the acquisition of the item of fixed machinery. Ownership of Iron Ltd I need to decide whether I should purchase the shares in Iron Ltd personally or whether the shares should be purchased by Sprint Ltd. I will be the managing director of Iron Ltd regardless of who purchases the shares. My preference would be to own Iron Ltd personally. However, I would be interested to learn of any advantages to the company being owned by Sprint Ltd. When Iron Ltd is eventually sold, I intend to use the proceeds to purchase a holiday home in Italy. Value added tax (VAT) Iron Ltd is not registered for the purposes of VAT. The current management of the company has told me that the level of bad debts is keeping the company’s cash receipts in a 12-month period below the registration limit of £81,000. However, I suspect that when I have the opportunity to look at the figures in more detail, it will become apparent that the company should be registered. |
Extract from the email from your manager
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Additional information 1. Sprint Ltd owns the whole of the ordinary share capital of Olympic Ltd. Both these companies are profitable and prepare accounts to 30 June each year. Both companies are registered for the purposes of VAT. 2. Sprint Ltd, Olympic Ltd and Iron Ltd are all UK resident trading companies. 3. Sprint Ltd will sell a warehouse on 1 February 2016. This will result in a capital loss of £38,000. 4. Iron Ltd currently makes up its accounts to 28 February each year. Following its acquisition, however, its next set of accounts will be for the 16 months ending 30 June 2016. 5. Iron Ltd currently has no associated companies. Please carry out the work set out below There will be quite a few points to draw to Christina’s attention, so keep each one fairly brief (a) Iron Ltd – Corporation tax payable Assuming the entire ordinary share capital of Iron Ltd is purchased by Christina personally on 1 November 2015, calculate the corporation tax payable by Iron Ltd in respect of the 16-month period ending 30 June 2016, and state when this tax will be due for payment. (b) Ownership of Iron Ltd Explain the tax matters which Christina needs to be aware of in order to decide whether the ordinary share capital of Iron Ltd should be purchased by herself, personally, or by Sprint Ltd. You should assume that Iron Ltd will be required to register for VAT. You should consider the tax implications of both: – the ownership of Iron Ltd; and – the eventual sale of Iron Ltd (by either Christina or Sprint Ltd). You should recognise that, regardless of who purchases and subsequently sells Iron Ltd, Christina intends to use the proceeds for personal purposes and that she is a higher rate taxpayer. (c) VAT registration Set out the matters which Christina should be aware of in relation to the need for Iron Ltd to register for VAT and the implications for that company of registering late. Tax manager |
Required:
Carry out the work required as requested in the email from your manager. The following marks are available:
Iron Ltd – Corporation tax payable.
Note: The following figures from the Retail Prices Index should be used, where necessary.
June 2012 241·8
December 2015 257·2
Sprint Ltd and Iron Ltd
Iron Ltd – corporation tax payable for the period ending 30 June 2016
Ownership of Iron Ltd.
Ownership of Iron Ltd
Ongoing ownership of Iron Ltd
Corporation tax
Iron Ltd will be associated with Sprint Ltd (and consequently Olympic Ltd) for the purposes of determining the rate of corporation tax payable by all three companies, regardless of whether the purchaser is Christina or Sprint Ltd. This is because Christina will have effective control of all three companies in both situations. Accordingly, when determining the rate of corporation tax payable, the corporation tax lower and upper limits will be divided by three.
It would be advantageous for Sprint Ltd, rather than Christina, to purchase Iron Ltd for the following reasons.
– It is possible that Iron Ltd will make a trade loss for the period ending 30 June 2016. If this were to occur, a proportion of the loss could be surrendered by way of group relief to Sprint Ltd and/or Olympic Ltd and be deducted in arriving at the taxable total profits of the recipient company. Whilst all three companies remain in the group, group relief would also be available between them in respect of any losses in future periods.
– Iron Ltd will join Sprint Ltd’s capital gains group on 1 November 2015. The capital loss to be made by Sprint Ltd on the sale of the warehouse could therefore be relieved against the chargeable gains to be realised by Iron Ltd on the sale of the industrial building and the fixed machinery. This would reduce the corporation tax liability of Iron Ltd by £7,764 (£22,791 – ((£113,135 – £38,000) x 20%)).
– A gain made by one of the companies in the group on the disposal of a qualifying business asset (land, buildings or fixed machinery used in the business) could be deferred if a qualifying business asset is purchased by any other company in the group during the qualifying period.
– Any future transfers of assets from one group company to another would take place on a no gain, no loss basis.
There is a possible disadvantage in Iron Ltd joining the Sprint Ltd group of companies in relation to capital allowances. The annual investment allowance will be split between the three companies if they are members of a group, whereas an additional full annual investment allowance would be available to Iron Ltd if Christina were to own Iron Ltd personally (unless Iron Ltd were to share premises or carry on activities similar to those of Sprint Ltd or Olympic Ltd).
Value added tax (VAT)
It may be beneficial for Sprint Ltd and Iron Ltd (and possibly Olympic Ltd) to register as a group for the purposes of VAT. This is because it would remove the need for Iron Ltd to charge VAT on the sales it makes to Sprint Ltd. This will, however, be possible regardless of who owns Iron Ltd because Christina will have effective control of all three companies in both situations.
Sale of Iron Ltd
Sprint Ltd owns Iron Ltd
Any chargeable gain (or loss) on the sale of the shares will be exempt due to the substantial shareholding exemption (SSE). This exemption will be available because Sprint Ltd will have owned at least 10% of the ordinary share capital of Iron Ltd for more than a year and both companies are trading companies.
Although the existence of the SSE would appear to be a significant advantage, it should be recognised that the proceeds of sale will then need to be transferred to Christina. This could be carried out via, for example, the payment of a dividend to Christina. As Christina is a higher rate taxpayer, she would have an income tax liability of 25% or even 30·55% of the dividend received.
Tutorial notes:
1. The rate of income tax payable by a higher rate taxpayer on dividend income is 25% (100/90 x (32·5% – 10%)). However, the dividend could cause Christina to become an additional rate taxpayer; the rate of income tax payable by an additional rate taxpayer on dividend income is 30·55% (100/90 x (37·5% – 10%)).
2. Credit was also available for reference to other ways in which the proceeds of sale could be transferred to Christina, for example, via the payment of a bonus.
Christina owns Iron Ltd personally
On a sale by Christina of the shares in Iron Ltd, there will be a chargeable gain equal to the excess of the sales proceeds over the price paid for the shares. This gain, after the deduction of any annual exempt amount not used against any other gains, will be subject to capital gains tax at 10% due to the availability of entrepreneurs’ relief.
Entrepreneurs’ relief will be available because Iron Ltd is a trading company and Christina will have owned at least 5% of its shares for more than a year, and Christina will be a director of Iron Ltd.
Tutorial note: It can be seen from the marking guide that it was not necessary to make all of the above points in order to score full marks.
Value added tax (VAT) registration.
VAT registration
Iron Ltd should be monitoring the level of its taxable supplies (excluding sales of capital assets), as opposed to its cash receipts, in order to determine when it needs to register for VAT
The implications of registering late are:
– Iron Ltd will be required to account for output tax on the sales it has made after the date on which it should have been registered. This will be a cost to Iron Ltd unless it is able to recover the VAT from its customers.
– A penalty may be charged for failing to register by the appropriate date. This penalty would be a percentage of the potential lost revenue where the percentage depends on the reason for the late registration.
– Interest may be charged in respect of the VAT paid late.