Business taxation

Band of taxable profit Tax rate £0 - £10,000 0% £10,001 - £50,000 23.75% £50,001 - £300,000 19% £300,001 - £1.5 million 32.75% £1.5 million or more 30%

The limits of the bands of profit taxable at each rate are reduced where there are associated companies or where the accounting period is less than 12 months. The starting rate and small companies rate apply to trading companies and certain property-investment companies. They do not apply to close investment-holding companies, which pay 30% whatever their level of profits.

Small but welcome savings all round for companies entitled to the lower rates of corporation tax. Calculations of the benefit of incorporating a business will need to be revisited in the light of these new tax rates.

Deduction of tax at source

Last year, the Chancellor abolished the requirement for companies to deduct income tax from interest, royalties, annuities and other annual payments to other UK companies. From October 2002 this is to be extended to similar payments made to specified bodies that are exempt from tax, for example pension funds.

Companies will be able to make royalty payments to non-residents where they have a reasonable belief that the non-resident would be able to reclaim the tax under a double taxation treaty.

This should ease the administration burden for companies involved in such transactions.

However, if it turns out that tax ought to have been deducted at source on payments to non-residents, the paying company remains liable. Companies will therefore have to be careful to be sure that the non-resident is actually entitled to the treaty relief.

Reform of taxation of intellectual property, goodwill and other intangible assets
The system of taxation for the acquisition and disposal of goodwill and other intangible assets has changed with effect from 1 April 2002. Prior to that date, companies could claim capital allowances on the acquisition cost of a limited range of items of intellectual property, as follows:

· patent rights;
· know-how relating to industrial techniques, mining, oil exploration, agriculture, forestry or fishing; and
· computer software.

No tax relief was available, except on a sale of the asset concerned, for acquisitions of other intangible assets, for example goodwill, copyrights and design rights.

The new rules, which will apply to companies only, will give tax relief for the cost of acquiring any of the above items in line with the amounts charged in the accounts.

Royalties payable and receivable in respect of any intangible assets within these rules will also be taxed on the basis of the accounts. Examples include patent royalties, copyright royalties etc.

Any receipts on the sale of these items will be taxed as income, with a limited rollover regime where the proceeds are reinvested in new intangible assets within a fixed period. The rollover regime will be very similar to that applying to capital gains.

There are transitional rules for assets already owned on 1 April 2002. There will be no deduction for the accounts depreciation on such items, but royalties payable and receivable, as well as sale proceeds on the disposal of these assets, will come under the new rules.

There are special rules to cover transfers of assets between connected parties, part disposals of intellectual property assets, rollover relief on the acquisition of shares in a company that holds intellectual property, business reorganisations, and companies leaving a group holding assets against which rollover relief has been claimed.

These rules give an extra incentive for the purchaser of a business to acquire it in the form of assets, rather than shares in an existing company. This can conflict with the interests of the selling group, which, because of the rules discussed below (see "Exemption for capital gains on substantial shareholdings"), may prefer to sell shares in a trading subsidiary, rather than selling assets.

Stamp duty used to be a disincentive to the acquisition of goodwill. Intellectual property in certain categories was exempted from stamp duty in 2000, and the exemption has now been extended to goodwill.

Companies will have to give careful consideration to their accounting policies to ensure that they can claim the maximum tax relief within the rules.

Exemption for capital gains on substantial shareholdings
From 1 April 2002, trading companies and holding companies of trading groups can sell certain shares in other companies free of tax. The exemption applies when a trading company or a trading group sells a shareholding of at least 10% in another trading company or trading group. There are detailed rules in the legislation to establish whether companies or groups are trading.

The company making the disposal has to have had the shares for at least 12 months during the period of two years prior to the disposal. This means, for example, that if company A has held exactly 10% of the shares in company B for at least 12 months it can sell half of that shareholding free of tax. The remaining 5% can then be sold free of tax at any time in the 12 months following the first sale. There is a special rule to extend these periods in certain circumstances, which can provide additional relief, but can also act as an anti-avoidance rule.

Because the new rules are intended to enable trading groups to reorganise their activities for commercial reasons, without tax constraints, the company or group that is making the disposal must retain its trading status after the disposal, as must the company whose shares are being sold.

As well as providing for gains to be exempt, the legislation means that losses arising on these disposals will no longer be recognised for tax purposes.

There are special rules for life insurance companies, postponed gains, appropriations to trading stock and other matters, the effect of which is to retain tax charges that might otherwise become exempt because of these new rules. Foreign exchange gains and losses arising from hedging transactions matched against investment in shares are also non-taxable or non-allowable as appropriate.

This is a major change in the basis of UK taxation of groups of companies, and should enable groups to carry out disposals of non-core operations without being constrained by tax considerations.

The tax relief is surrounded by detailed conditions and anti-avoidance rules, however, so specific advice will be needed in particular cases.

Existing companies may wish to consider whether their operations should be separated into wholly-owned subsidiaries, to prepare for potential future disposals on a tax-free basis.

Early planning is recommended, given the length of time for which the shares in the subsidiary company have to be held to benefit from the relief.

Companies leaving groups
Chargeable assets (for example, land and buildings) can be transferred between companies in the same group free of tax, even if there is an unrealised gain on the asset.

If the transferee company leaves the group within six years, any such unrealised gain becomes taxable under Section 179 TCGA 1992.

This has in the past been an issue in relation to disposals of subsidiary companies, because the "Section 179" tax charge falls on the subsidiary that leaves the group, and thereby becomes, in effect, a liability of the purchaser.

New rules have therefore been introduced, in tandem with the exemption for disposals of shares discussed above, to allow this tax charge to be reallocated to a member of the selling group.

In addition, it is now possible to claim rollover relief in respect of a Section 179 charge. If the charge has been allocated to a member of the selling group, rollover relief will be claimed within that group. Otherwise, it will be claimed by the company leaving the group or elsewhere in the purchaser's group, as appropriate.

These rules came into force on 1 April 2002.

In the past, it has been normal for the selling group to give an indemnity to the purchasing group in respect of any Section 179 charges in the company being sold. There will now have to be negotiations in these circumstances over potential reallocation of the Section 179 charge to the selling group. In certain cases, it may be appropriate for the purchasing group to accept the liability if rollover relief can be claimed, with an appropriate adjustment to the purchase price.

Research and development
Since April 2000 small and medium sized companies ("corporate SMEs") have been able to claim enhanced tax relief for research and development ("R&D") expenditure. Corporate SMEs have also been able to claim an actual payment from the Government amounting to 24% of the qualifying expenditure in cases where they have not yet started trading, or have insufficient profits to cover the tax-deductible expenditure.

This tax relief was not available for companies failing to qualify as corporate SMEs, as defined under European Commission rules for state aids. These rules define a corporate SME as a company which, taken together with any other company in which it holds 25% or more of the capital or voting rights, has:

· fewer than 250 employees; and
· either or both of:
· an annual turnover not exceeding 40 million Euros (about £25m); and
· an annual balance sheet total not exceeding 27 million Euros (about £17m).

In addition, if the company concerned is more than 25% owned by one or more other companies that fall outside the definition of a corporate SME, then the company itself also fails the test.

The new rules give an enhanced tax relief for R&D expenditure to "large" companies, in other words those failing the SME test above. This means a "super-deduction" in working out taxable profits, giving tax relief for 25% more than the actual expenditure on R&D. Large companies will not be able to claim a cash payment from the Government in respect of excess R&D expenditure, as corporate SMEs can, but otherwise the rules are broadly similar.

In addition, enhanced tax relief will be available (without the cash refund element) to corporate SMEs carrying out subcontracted work on behalf of large companies.

Furthermore, the extra tax relief will be available for funding provided to universities, charities and other non-profit organisations for collaborative research, as well as for the costs of work subcontracted by large companies to such bodies.

There is a special relief for pharmaceutical companies. In calculating their profits for corporation tax, companies will be entitled to deduct an additional 50% of qualifying expenditure on the research and development of:

· vaccines and medicines for the prevention and treatment of TB and malaria;

· vaccines for the prevention of HIV infection; and

· vaccines and medicines for the prevention of the onset of Aids or the treatment of Aids resulting from infection by HIV in certain prescribed forms which occur mostly in countries in the developing world.

These tax reliefs will be available for expenditure incurred on or after 1 April 2002.

Accounting systems will need to be able to identify qualifying R&D costs, in the various categories above.

Foreign exchange gains and losses, derivative contracts and loan relationships
In 1993, 1994 and 1996 the Government introduced complex legislation dealing with the company taxation of foreign exchange gains and losses, financial instruments (i.e. currency hedging transactions and the like) and loan relationships (i.e. debts owed to and by companies). These rules are complex, and will typically have only a limited application to most companies outside the City of London.

The whole system has now been reformed and consolidated. The result is a mammoth piece of legislation, together with regulations and detailed explanatory notes. It would take a large amount of space to do justice to the full extent of the reforms. The broad intention is to make the taxation of these items match their treatment in companies' accounts.

One or two key points arising from these new rules are set out below:

· the foreign exchange gains and losses legislation is repealed, so that these items will be wholly dealt with within the loan relationships and "derivative contracts" legislation (the new name for the financial instrument legislation);

· the foreign exchange transitional rules will come to an end, meaning that some profits postponed from 1993 will now fall into tax;

· companies will be able to postpone exchange gains and losses on loans that are "as permanent as equity";

· there will be a "non-elective" set of matching rules, dealing with currency hedging transactions;

· where interest on a loan from a pension scheme is paid more than 12 months after the accounting period in which it accrues, that interest will be deductible on a "paid" rather than "accrued" basis; and

· a number of detailed anti-avoidance rules are introduced.

Enhanced capital allowances on cars and other assets
With effect from Budget Day, newly-registered low emission or electronically driven cars will qualify for 100% capital allowances, and the retail price cap of £12,000 which would otherwise apply is also removed. Low emission is defined as no more than 120 grams of CO2 per kilometre.

In addition to 100% capital allowances on such vehicles, businesses will also be able to claim 100% relief on expenditure on plant and machinery to refuel cars running on natural gas or hydrogen fuel. Examples listed are storage tanks, compressors, pumps, controls, gas connections and filling equipment.

The 100% relief is also to be allowed for expenditure on the leasing of such equipment, as well as low emission cars. All 100% relief will be available for six years (to 31 March 2008.)

The term "low emissions" might be better described as ultra-low emissions, since the lowest level for the new CO2 tariff for taxing company cars in 2002/03 is 165 grams/km. Only two petrol-driven cars are currently listed in emissions tables published by the Vehicle Certification Agency, both two-seaters, namely the Honda Insight and the Smart car - hardly company car candidates.

However, there are several diesel cars that come in bang on, or just under, 120 grams/km.

The four-seater cars currently appearing in the VCA's "top ten" list are the "eco-diesel" versions of the Audi A2, Seat Arosa, Vauxhall Astra, VW Lupo, Ford Fiesta, Peugeot 206/307 and the Renault Clio.

Because these and similar low emissions vehicles will all be taxed at the minimum 18% company car tax rate for the next three years, it opens up the possibility of providing highly tax-efficient employee vehicles, or perhaps second or family cars, as part of a remuneration planning exercise; plus 100% tax relief for the business, to boot!

Changes to Construction Industry Scheme ("CIS")
As announced in the autumn statement, there will be a relaxation of the rules for those businesses operating within the CIS that hold registration cards only. Such businesses must receive their payments under deduction of tax and can currently only claim this as a credit against their corporation tax (or claim repayment if that tax is nil or low.) From 6 April 2002 they will be able to offset this tax against any PAYE or CIS deductions they themselves have to pay to the Collector of Taxes, and so should be able to get much quicker relief.

Relief for corporate donations
A new measure is introduced for companies that operate in the field of medicines and medical equipment. Where such a company donates from its trading stock qualifying supplies or equipment for humanitarian purposes a tax charge will not arise on the deemed profit that is made by reference to the item's sales value. The change applies to donations on or after 1 April 2002.

UK branches of foreign companies
Inward investors may be affected by changes in the way in which profits of branch operations are to be taxed. There will be consultation on the technical detail. The rules are expected to apply to accounting periods starting on or after 1 January 2003.

In general terms, the effect of the new rules will be to limit the amount of tax relief for interest that a branch operation of a non-UK company can deduct in calculating its profits. The Government expect that this will mainly affect the banking sector, though other types of businesses may be caught.

Inward investors have always had to be careful to structure their investments in the UK in the right way, choosing between setting up a branch or forming a UK subsidiary to optimise their tax position. The new rules will complicate those calculations further, and a review of both future intentions and current structures may be in order.

Controlled foreign companies
There is to be a general tightening of the rules which will make it much more difficult for companies affected by this legislation to avoid being caught.

A controlled foreign company is one that is:

· not itself resident in the UK;
· taxed at less than 75% of the rate that it would have paid had it been resident in the UK; and
· controlled to a significant extent by individuals or companies who are resident in the UK.

Rules exist to prevent UK companies reducing their UK tax liabilities by diverting profits to foreign companies which they control and which are situated in lower tax regimes. Broadly, the rules charge UK parent companies to tax on the profits that would otherwise escape tax.

This was not unexpected. Many companies had found ways round these anti-avoidance rules.