Corporation tax rates

The corporation tax rates continue to be a 0% starting rate, a 19% small companies rate and a main rate of 30%. However the benefit of the 0% rate may not apply to many small companies (see below). The profits limits continue to be reduced for a company that is part of a group or has associated companies.

Small companies

There is no doubt that the introduction of a 0% starting rate of corporation tax in 2002, together with national insurance increases which took effect in 2003, have done much to encourage many businesses to form companies.

The government is therefore making changes so that a minimum rate of corporation tax of 19% will apply when profits are distributed to non-company shareholders. The minimum rate will apply to distributions made on or after 1 April 2004. Lower rates of corporation tax will continue to apply where profits are left in the company.

Example

Gordon owns all the shares in a trading company Brown Ltd. The annual profits are £25,000 after a small salary has been paid to him. All the profits remaining after corporation tax has been deducted are paid out as a dividend. Gordon has no other income.

Under existing rules the corporation tax payable will be £3,562.50 (£10,000 at 0% + £15,000 at 23.75%). There will be no income tax on the dividend as Gordon’s income does not fall into the higher rate band.

Although detail is a little thin on the ground it would appear that under the new rules the corporation tax payable will be £4,750 (£25,000 at 19%). Gordon will therefore receive a lower dividend. There will continue to be no income tax on the dividend as Gordon’s income does not fall into the higher rate band.

Comment

The new measure is not as draconian as many feared. It only affects companies which make less than £50,000 of annual profits after salary deductions. And if those companies do not distribute all the profits in order to provide funds to expand the business they will continue to have some benefit from the 0% starting rate. Unfortunately the Inland Revenue press release does not expand upon how much benefit the company will obtain in such circumstances.

Action point

As the minimum rate applies to distributions made on or after 1 April 2004, companies with annual profits below £50,000 may wish to pay a dividend before this date.

Small and medium-sized company thresholds

Increased thresholds have been introduced and are used to determine which businesses are entitled to first year allowances (FYAs) on plant and machinery. The new limits apply for financial years ending on or after 30 January 2004.

The small company turnover threshold is doubled to £5.6 million and the balance sheet total is doubled to £2.8 million. The employee limit remains at 50.

The medium-sized company turnover limit is increased from £11.2 million to £22.8 million and the balance sheet total increased to £11.4 million from £5.6 million. The employee limit remains at 250.

Generally to satisfy either of the definitions, a company must fall within at least two of the thresholds.

FYAs for small businesses

The rate of FYAs for expenditure by small businesses on most plant and machinery will be increased from 40% to 50% for a period of one year. This will apply to expenditure incurred on or after 1 April 2004 for companies and 6 April 2004 for unincorporated businesses.

Action point

Since 1 April 2000, small businesses have been able to claim 100% FYAs on expenditure on ICT - specifically computers, software and internet-enabled mobile phones. This rate comes to an end on 31 March 2004.

Watch any expenditure incurred between 1 April and 5 April 2004 for an unincorporated business - only 40% FYAs will be due.

Capital allowances in Enterprise Areas

The government plans to introduce a 100% capital allowance for the capital costs of renovating business premises in the 2,000 Enterprise Areas. The allowance, which is subject to state aid approval, will apply to premises that have been vacant for a year and will be known as the ‘Business Premises Renovation Allowance’. It is planned to take effect in 2005.

Partnership losses

The Inland Revenue has announced that certain partnership losses are to be the subject of its latest attack.

Where a partnership sustains a trading loss, the basic rule is that partners can claim relief for the loss against their other income and capital gains.

The Inland Revenue has decided that this is open to manipulation. Therefore with effect from the date the announcement was made, namely 10 February 2004, relief will be restricted where partners did not spend ‘a significant amount of time working in the trade when the losses arose’. In the Revenue’s words ‘the changes will not therefore affect genuine traders who actively run their own trade’.

Comment

The measure of ‘significant’ is intended to be a minimum of ten hours per week and will only include time spent by the partner ‘playing an active and personal role in the operations of the trade’. Clearly it is going to be difficult to measure the time spent. However anyone trying to start a new partnership whilst continuing to hold down another job is likely to fall foul of the new rules if a trading loss should arise in the new partnership.

Corporation tax reform - the process continues

The process of undertaking a major overhaul of the corporation tax system has been underway now for two years. Consultation continues with a view to:

• bringing companies’ capital gains into an income regime
• considering rationalising and simplifying the headings (‘schedules’) under which a company’s income is taxed
• reviewing the differences in tax treatment between trading and investment companies.

The issues of transfer pricing and management expenses have been identified as a priority for change and are detailed below.

Transfer pricing

Transfer pricing rules require the market value of transactions between connected businesses to be recognised for tax purposes. Thin capitalisation is the excessive use of debt finance rather than equity finance between connected companies. Currently these rules only apply to cross-border transactions.
From 1 April 2004, the transfer pricing rules will be extended to cover purely domestic transactions as well. The thin capitalisation rules will be abolished and effectively incorporated into the transfer pricing regime.

To avoid a major compliance burden on smaller companies, the new rules will not usually apply to small or medium-sized enterprises, although the Inland Revenue will have the power to apply them to medium-sized enterprises in ‘exceptional cases’.

Comment

In other cases the Inland Revenue will expect transactions between related companies to be on a demonstrably arms-length basis. They will expect to see documentation to justify the pricing basis being used although they accept that in small cases, or in cases where there is no obvious tax advantage to be gained because tax rates are similar, it is not reasonable to impose a detailed record keeping requirement.

Expenses of managing investments

Corporation tax relief for the expenses of managing investments is currently limited to investment companies. With effect from 1 April 2004, this restriction will be abolished and relief will be available to any company with ‘investment business’.

Relief for this type of expense will be given in line with accounting rules. Specifically there will be a disallowance of any capital expenses.

Comment

The change will remove the need to establish a group management company simply to obtain relief for investment management expenses. In future, companies that carry on both trading and investment activities will qualify for relief.

Research and development (R&D) expenditure

In 2000, an R&D tax credit was introduced for small and medium-sized companies (SMEs). This enables SMEs to claim tax relief on 150% of qualifying R&D costs. The scheme was extended to large companies in 2002 enabling them to claim tax relief on 125% of qualifying R&D costs.

Some companies have faced difficulties in determining whether their expenditure qualified for the relief. The government has therefore:

• published revised guidelines which replace the previous requirements for ‘novelty’ and ‘innovation’ with the need to show an ‘advance in science and technology’
• proposed a new category of qualifying costs to include software, water, power and fuel.

For large companies the changes take effect from 1 April 2004. For SMEs, changes will take effect as soon as state aid approval has been received.

Comment

The main purpose of the changes is to make eligibility for the credit clearer and to widen (slightly) the range of qualifying costs.

Reform of the Construction Industry Scheme (CIS)

A special tax deduction scheme for the Construction Industry has existed since 1972. The current CIS has been in place since 1999 but retains the same basic structure as before, namely reliance on paper vouchers to evidence payments between contractors and subcontractors.

The Chancellor announced in his 2003 Budget that a new CIS would be introduced in April 2005. However the industry expressed concern that this would be too tight a deadline. The result is that implementation has now been deferred until April 2006. The main proposals are to:

• replace Registration Cards and Gross Payment Certificates with a verification service
• introduce an employment status declaration
• replace vouchers with periodic returns.

Tax and accounting

International Accounting Standards (IAS) will apply to certain UK companies from 2005. Legislation will be introduced to:

• ensure that IAS accounts are valid for UK tax purposes
• amend the legislation on loan relationships, derivative contracts, intangibles and R&D to accommodate accounting changes.

Community Amateur Sports Clubs (CASCs)

In the December 2003 Pre-Budget Report, the Chancellor announced that from April 2004 CASCs would be given 80% rates relief.

In addition, it has been confirmed that they will be exempt from corporation tax on profits derived from trading, if their trading income is under £30,000, and on profits derived from property if their gross property income is under £20,000. CASCs that do not exceed these thresholds will not have to complete a corporate tax return on an annual basis. The new limits apply from 1 April 2004.

Landlord’s energy saving allowance

There is generally no tax deduction against revenue for expenditure on new capital assets in computing the taxable profits of a property business. Landlords who pay income tax and who let residential property will be given an allowance up to a maximum of £1,500 when they install loft or cavity wall insulation in the property. The relief applies for expenditure incurred from 6 April 2004.

Investment in the film industry

The tax relief for British qualifying films, which is due to expire on 1 July 2005, will be replaced by a new relief for production expenditure incurred.