Chapter 2Application of Income Tax Principles to the Taxation of Companies
The aim of this chapter is to teach students about how income tax rules apply to the calculation of profits subject to corporation tax and to understand the main differences. It also teaches students to identify and extract the necessary information from a company’s financial reports to prepare the corporation tax computation.
On completing this chapter, you will be able to:
|2.1||Use the relevant sources of law to compare the rules that apply to deductions allowable in arriving at taxable income for corporation tax and those allowable for income tax purposes||38|
|2.2||Identify the disclosure notes and other sources that are relevant to the preparation of the corporation tax computation||57|
|2.3||Identify the disclosure notes that are relevant to other taxes||62|
|2.4||Calculate the taxable profits of an Irish corporate taxpayer||65|
|2.5||Justify the deduction or otherwise of expenses based on legislation and case law||71|
Capital Taxes Fundamentals
■ Chapter 4 Disposals
Personal Taxes Manual
■Chapter 4 Taxation of business income – Schedule D Case I and II
■Chapter 6 Computation of capital allowances for Schedule D Case I and Case II
■Chapter 9 Taxation of Rental Income: Schedule D Case V
■Chapter 10 Leases and lease premiums
■Chapter 15 Taxation of investment income: Schedule D Case III
■Chapter 16 Taxation of other income: Schedule D Case IV
■Chapter 17 Taxation of dividend income: Schedule F
■Chapter 5 Basics of Company Law
PRINCIPAL LEGISLATIVE PROVISIONS
■Chapter 6 of Part 4, Chapter 5 of Part 5, Chapter 3 of Part 7, Chapter 2 of Part 9, Part 11, 11C and 11D, Part 17, Part 30 and Sections 18, 26, 44, 58, 78, 81, 91, 109, 172A-172M, 239, 243, 247, 317, 520–531, 554, 840, 847A, 848A, 1080 and Schedule 26A of TCA 1997
Corporation Tax, Finance Act 2010, Irish Tax Institute
■Chapter 2 Income Classification, Rates and Dates
Revenue Tax Briefing
■ Tax Briefing 11: Keyman insurance
■ Tax Briefing 24: Principles of taxation for finance leases
■ Tax Briefing 57: Classification of activities as trading (CT)
RELEVANT PAST EXAM QUESTIONS - BUSINESS TAXES: APPLICATION & INTERACTION
Note the content of this chapter moved from Part 2 to Part 1 for the 2017/2018 course
■ 2015, Summer, Question 1
■ 2015, Autumn, Question 1
■ 2016, Summer, Question 1
■ 2016, Autumn, Question 1
■ 2017, Summer, Question 1
■ 2017, Autumn, Question 1
■ 2018, Summer, Question 1
RELEVANT PAST EXAM QUESTIONS - PERSONAL & BUSINESS TAXES FUNDAMENTALS
■ 2018, Summer, Question 5
2.1.Use the relevant sources of law to compare the rules that apply to deductions allowable in arriving at taxable income for corporation tax and those allowable for income tax purposes
2.1.1.Comparison of income tax and corporation tax deductions allowable
In order to appreciate the difference between the treatment of expenses for unincorporated and incorporated entities, students should understand the legal difference between an unincorporated business (e.g. a sole trader) and the shareholders of an incorporated business (a company).
You should refer to Chapter 4 of the Law manual.
■ A sole trader is taxable under Case I/II on all his trading/professional income in the taxable period.
■ In calculating tax-adjusted Case I/II, he receives no deduction for his drawings or for his personal expenses during the period.
■ Even though the accounts may refer to a salary for the sole trader, that salary expense must be added back in calculating the sole trader’s tax adjusted trading profits. Otherwise, trading income would be incorrectly classified as Schedule E income for tax purposes. The owner cannot employ himself and accordingly is taxed under Case I/II on all his earnings in the period irrespective of whether or not he spends or draws down these amounts.
■ A sole trader must also add back the private element of any expenditure booked to the accounts, e.g. the private element of any motor expenses.
■ Companies are separate legal entities distinct from their owners and they are taxed on the full amount of their own income and gains. Shareholders are taxed on profits of a company only to the extent that such profits are distributed (or deemed to be distributed) by the company (e.g. by way of a dividend).
■ The vast majority of companies in Ireland are family controlled; they will usually have two shareholders of which either one or both work in the company as full-time directors. The directors will draw a salary from the company, upon which they will pay tax under Schedule E and the company will get a deduction for this cost. The company is then taxed on the profits after the deduction for directors’ salaries.
■ Similarly, where the company funds personal or private expenses of the shareholders who are directors, such amounts are allowable in full on the basis that the expenditure is a cost of rewarding employees and the shareholder directors will be taxed on these amounts under the BIK rules (remembering the special rules that apply to employer pension contributions). If the shareholder is not an employee or director the cost will not be allowed as a deduction for corporation tax purposes unless it is incurred wholly and exclusively for the purposes of the trade of the company and is not deemed to be a distribution out of profits of the company. See chapter 11 for the tax implications of these types of transactions.
■ Capital allowances are allowed as deductible trading expenses for companies whereas the unincorporated business will deduct them from his taxable Case I/II income.
■ A sole trader or a partner in a partnership cannot claim mileage or subsistence expenses as they are not employees. In contrast, if they were employees/directors of a company, the company could pay mileage/subsistence amounts to employees/directors and claim a deduction for these expenses in calculating its taxable Case I/II income.
The profits of the company are owned by the company and the shareholder is not taxed until he takes them from the company.
2.1.2.Outline the statutory adjustments to accounting profits of a trade and their application
The Statement of Comprehensive Income contains the company’s results for the period in question. This is the starting point in the calculation of taxable profits (other than for investment companies) and therefore should be closely reviewed for any possible adjustments required.
The following items are not deductible in calculating tax-adjusted Schedule D Case I/II profits:
■ Business entertainment costs (including the provision of accommodation, food and drink) (Section 840(2) TCA 1997), although staff entertainment is allowable.
■ Interest on late payment of taxes e.g., VAT, PAYE/PRSI, corporation tax, etc. (Section 1080(3) TCA 1997). This makes delaying the payment of tax a very expensive source of finance.
■ General provisions for repairs (only amounts actually incurred on repairs are deductible) (Section 81(2)(d) TCA 1997)
■ Capital expenditure on improvements to premises occupied for the purpose of the trade (Section 81(2)(g) TCA 1997)
■ Any other capital expenditure to be used in the trade or profession (Section 81(2)(f) TCA 1997)
■ Certain motor leasing expenses - Section 380K – Section 380P TCA 1997 (Part 11C) applies whereby the carbon dioxide emissions of the vehicle are taken into account in calculating the restriction of the allowable expense.
All of the above categories apply equally to companies as they do to individuals.
There are other statutory adjustments to accounting profits. These fall into four broad categories:
(i) Specifically disallowed Case I expenses
(ii) Specifically allowable Case I expenses
(iii) Expenses which are disallowed or allowable under the general “wholly and exclusively” test in Section 81(2)(a) TCA 1997
(iv) Exempt trading or professional related income and income taxed under another Schedule or Case
(i) Specifically disallowed Case I expenses
General bad debt provisions
■ Section 81(2)(i) TCA 1997 disallows a deduction for “any debts”, except for any specific bad debts and specific bad debt provisions.
■ IAS 37 does not permit companies to create general provisions, including general bad debt provisions. Remember though, a company may still create general provisions that fall under the materiality threshold of their auditors or the company may prepare branch accounts (which may not be audited) that contain general provision amounts.
■ A subsequent recovery of the specific bad debt provision is taxable as Case I income (Section 87(1) TCA 1997) – NOTE: this section applies to expenses other than bad debt expenses where a company has taken a deduction for the expense but is subsequently released from an obligation to make a payment. For example, where a company reaches an agreement with creditors that it will pay them 60 cent in every Euro owed, the 40 cent not paid is treated as income of the company to the extent the company had previously taken a Case I deduction for any of the amounts owed to those creditors).
The bad debts expense in the Statement of Comprehensive Income of A Ltd is €55,000 and can be broken down as follows:
|Bad debts written off as irrecoverable||60,000|
|Debts previously written off now recovered||(20,000)|
|Movement in (specific) bad debt provision|
|– Opening provision||25,000|
|– Closing provision||40,000||15,000|
|Expense to be included in the Statement of Comprehensive Income||55,000|
1. The bad debts written-off are allowed as a Case I deduction in full while the bad debts recovered are taxed as trading income.
2. The increase in the (specific) bad debt provision of €15,000 is allowed in full as a Case I deduction.
i.e. in effect the full €55,000 Statement of Comprehensive Income charge is allowable as a Case I deduction and no adjustment is required in the company’s tax computation.
Included in the Statement of Comprehensive Income of B Ltd is a bad debts expense of €110,000. This charge can be broken down as follows:
|Bad debts written off||50,000|
|Bad debts recovered||(10,000)|
|(General) bad debt provision||- Opening||20,000|
|Expense to be included in the Statement of Comprehensive Income||110,000|
Assess the allowability of the above expense for tax purposes.
■Any royalty paid in respect of the user of a patent is not a deductible Case I expense (Section 81(2)(m) TCA 1997). However, while a deduction for such an amount accrued in the accounts (charged as an expense in the income statement) is disallowable, the gross amount of patent royalties actually paid in relation to a trade will normally be allowed as a charge under Section 243(2) TCA 1997. You will learn more about this in Chapter 4.
All profits and losses on the disposal of any type of asset should be deducted and added-back respectively. These amounts are determined under accountancy rules involving depreciation and have no correlation to capital allowances or capital gains and losses.
Items not related to the trade or profession
■Under Section 81(2)(e) TCA 1997, any loss not connected with the trade or profession may not be deducted in arriving at the Case I profit or loss. So, for example, a rental loss may not be deducted in arriving at the Case I profit for the accounting period. Chapter 5 discusses the corporation tax treatment of losses.
■Any expenses not wholly or exclusively incurred for the purposes of the trade or profession are, of course, not deductible under Section 81(2)(a) TCA 1997. These expenses would include, for example, a spare parts car dealer with an annual subscription to a monthly golf magazine. This would not be a qualifying cost whereas a golf school or supplies shop could claim the subscription as a cost incurred wholly and exclusively for the trade. Expenses incurred by a shareholder of a company for personal use would not be allowed as they would not be incurred wholly and exclusively for the trade. The exception to this is where the shareholder is also an employee or director and the expense is treated as a taxable emolument of that employee/director (i.e. a BIK subject to PAYE/PRSI). In that case, the expense would be allowable in calculating the company’s taxable Case I/II income. This can be contrasted with the treatment of non-allowable expenses of a sole trader which are always added back in the computation of their taxable Case I/II income.
■Legal expenses relating to capital expenditure such as the proposed or actual purchase of a building or costs associated with obtaining planning permission are not allowed (Section 81(2)(g) TCA 1997). They would be treated as a part of the capital cost of acquiring the asset and may be deductible against future gains (as an incidental cost of acquisition in accordance with Section 552 TCA 1997).
Exception to the rule: Interest on capital expenditure
Although Section 81(2)(h) TCA 1997 disallows interest on “any sum employed…as capital” (Section 81(2)(g) TCA 1997), following the Sean MacAonghusa (Inspector of Taxes) v Ringmahon  ITR 117 case a deduction is allowed for interest, where the interest is paid wholly and exclusively for the purposes of the trade carried on by the company in the period in which the interest is paid (regardless of the purpose for which the original loan principle was drawn down).
Interest and capital gains tax
Generally, for capital gains purposes, interest, even if charged to capital, is not allowed as a deduction in calculating chargeable gains or allowable losses on the disposal of an asset where borrowings were drawn down to acquire that asset and interest was paid on the borrowings (there is one exception to this rule which is outlined in Section 552(3)(a) TCA 1997). Section 81(3) TCA 1997 specifically states that a company will not be prevented from taking a deduction in calculating taxable Case I/II income for interest which is charged to capital for accounting purposes (for example under FRS 102 Section 25 or IAS 23). The company must still be able to demonstrate that the interest was incurred wholly and exclusively for the purposes of the trade in order to treat capitalised interest as deductible against trading income. To the extent that a company treats capitalised interest as a deductible trading expense, it is not allowable in calculating any gain or loss on the disposal of an asset for CGT or corporation tax on chargeable gains purposes (Section 554(1) and Section 78(6) TCA 1997).
Dividends and Distributions
Section 76(5) TCA 1997 provides that no deduction is to be made in computing income for corporation tax purposes (from any source) in respect of dividends or other distributions paid or payable by the company.
(ii) Specifically allowable Case I expenses
Pension fund contributions
Additionally, where an employer makes abnormally high ‘special’ contributions, Revenue will determine a period over which the deduction will be allowed depending on the circumstances (Section 774(6)(d) TCA 1997). The ‘spread’ is usually calculated by dividing the special contribution by the normal annual contribution, subject to a maximum spread of five years. Chapter 4 of the Revenue Pension Manual outlines that where this division results in a fraction of a year, it will be rounded down if it equals or is less than 1/2, and rounded up if it exceeds 1/2.
The normal annual contribution of a company which is allowed as a Case I deduction is €50,000. During the year the company made an additional special lump sum contribution of €150,000 to the approved scheme. The special contribution will be allowable over a 3 year period (i.e. €150,000/€50,000).
Tadhg Ltd’s monthly employer pension contributions are €10,000. The payment is made on the 28th of each month, however the December 2018 payment was not made until 9th January 2019. The year end is 31 December 2018 and in that year a special contribution of €300,000 was also made. The pension charge in the Statement of Comprehensive Income is €420,000, representing €10,000 per month for 12 months and €300,000.
Calculate the total tax deductible employer pension contribution for the year end 31 December 2018.
You will learn more about employer relief for contributions to pension schemes in your Part 3 Studies.
Statutory redundancy payments made by a company are an allowable Case I expense under Section 109(2) TCA 1997. This is the case even if the payment is made after the company has ceased to trade (Section 109(2) TCA 1997).
Any excess over statutory payments (i.e. ex-gratia payments) can be a deductible expense under the general rule in Section 81(2)(a) TCA 1997 in the case of an ongoing trade but not for a trade that is ceasing.
Donations to selected charities and sporting bodies
Gifts of money, i.e. donations, made to an approved body which are to be used for the purposes of approved projects (Section 848A TCA 1997) can be a deductible Case I expense. The list of approved bodies is set out in Schedule 26A TCA 1997.
The minimum qualifying gift is €250 per charity. No maximum limit is imposed by the section (Section 848A(1) TCA 1997). There are a number of conditions which must be met in respect of the ‘relevant donation’:
■ there must be no condition attached to the donation that would require the approved body to repay the amount donated to the company;
■ no benefit is received directly or indirectly by the donor or a person connected with the donor, as a result of the donation;
■ the donation is not conditional on the approved body acquiring a property, other than by gift from the donor or a person connected with the donor;
■ the donation would not otherwise be deductible for corporation tax purposes (Section 848A(3) TCA 1997).
Relief for the company is afforded by treating the donation as a tax deductible trading expense of a trade carried on by the company (Section 848A(4) TCA 1997). The relief applies for donations of sums of money and/or shares in publicly quoted companies (see definition of “relevant donation” in Section 848A(1) TCA 1997). Therefore, the donation of a piece of land to an approved charity would not meet the requirements of this section but shares in Diageo plc, Microsoft Corporation, etc. would qualify for relief.
A further relief for donations is contained in Section 847A TCA 1997. The relief is for donations to Revenue approved tax exempt sporting bodies. The conditions are similar to those contained in Section 848A TCA 1997 for making the ‘relevant donation’. The donation must be used by the sporting body for capital purposes e.g. sports buildings, pitches, facilities etc. The donation is allowable as a trading deduction against the company’s income.
Schedule 26A TCA 1997 deals with the conditions that must be met for charities to be treated as “approved bodies”. It allows a “relevant donation” to be made to charities based in the EEA and registered with the Revenue Commissioners. The inclusion of EEA countries follows a case taken in Germany in relation to an Italian charity which was taxed on German income whereas similar resident German charities were exempt (Centro Di Musicologia Walter Stauffer v Finanzamt Munchen fur Korperschaften (C-386/04)). The German rules were deemed to be incompatible with the EU free movement of capital directives.
Care should be taken to ensure that advertising costs are not misallocated to donations. For example, the payment of €1,000 to the local football club can be treated as advertising if the company’s name appears in the match programme together with a promotional feature, etc. and is not treated as a donation. In this case, assuming the cost is incurred wholly and exclusively for the purposes of the trade, the expense would be a deductible expense under Section 81 TCA 1997.
Certain sums paid to employees as restrictive covenants
■ You will learn about the tax treatment of restrictive covenants in the hands of employees during your Part 2 Personal Taxes: Application and Interaction module.
■ Restrictive covenants can be used by companies in a wide range of contexts. One of the most common is a covenant which restricts an employee from leaving to join a competitor within a certain period of time.
■ Any sum paid or the value of any consideration given to an employee in respect of a restrictive covenant which is taxable income for that employee is an allowable deduction in the accounting period in which the sum is paid/consideration given (Section 127(4) TCA 1997).
■ Restrictive covenants paid to competitors are not allowed as a deductible trading expense if they achieve a permanent result which could make it a capital payment. You should refer back to the Capital Gains Tax manual where a full discussion of the case law on this issue is presented.
Walker HM (Inspector of Taxes) v Joint Credit Card Company Ltd 55 TC 617
In this UK tax case, the company paid a potential rival £75,000 in consideration of the rival agreeing to cease trading in credit cards. Legal fees were also incurred and claimed. The Revenue did not dispute that the £75,000 was expended wholly and exclusively for the company’s trade.
The court, however, held that the expenditure was on a capital account and identified two permanent results achieved by the expenditure:
(i) The plaintiff would be unchallenged with no rival; and
(ii) its existing goodwill would be protected for all time by the closing down of an aggressive and possibly unscrupulous rival.
■ Compensation payments made by a company to a customer to free that company from an onerous contract are allowable where the assets to which the compensation relates are revenue in nature (Anglo Persian Oil Co v Dale  16TC253 and Vodafone Cellular & others v Shaw  69TC376). In the later case, the onerous contract was a requirement to pay an annual license fee which would have been a deductible expense had it been paid. Therefore, the payment to free the company from this contract was also treated as deductible. Where the assets are capital in nature (e.g. a lease), the compensation payments would not be deductible and would have to be added back in the corporation tax computation (Bullrun Inc v CIR (SPC 248)).
Certain amounts in respect of the employment of the long term unemployed
■ The Jobs Plus Scheme grants a tax free rebate to the employer company (Section 226(1)(k) TCA 1997) of €7,500 if the individual was unemployed for between 12-24 months and €10,000 for more than 24 months immediately preceding the date he or she commences the qualifying employment. The rebates are paid over two years.
Medical insurance premiums paid on behalf of employees
It is common practice for Irish companies to pay their employees’ medical insurance premiums for VHI/Laya Healthcare/Aviva etc on their behalf as a taxable BIK.
You will have learned about the tax relief at source (TRS) that applies to individuals on paying a premium to an approved medical insurance provider (Section 470(3) TCA 1997). So, for example, if the gross premium for an individual’s annual medical insurance policy renewal was €1,000, the TRS would be €200 (i.e. the gross premium at the current standard rate of income tax which is 20%). The insurance provider would only charge the individual €800 and recover the €200 credit directly from the Revenue.
A company cannot qualify for this TRS as it is not an individual (Section 470(3) TCA 1997). As a result, the company:
■ pays the net amount of the medical insurance premiums to the relevant medical insurance provider,
■ is obliged to pay the 20% credit to Revenue along with its annual corporation tax liability (Section 112A(3) TCA 1997),
■ is entitled to an allowable Case I deduction for the gross amount of the medical insurance premiums, not the net amount (Section 112A(3) TCA 1997).
The maximum TRS is €200 per adult and €100 per child.
It should be noted that where the payment of the medical insurance premium by the individual to the insurance company is facilitated by the employer (as compared with the provision of a taxable benefit from the employer to the individual) the company is not obliged to pay the extra 20% credit to Revenue. This is because the payment is being made by an individual who is entitled to the TRS.
A Ltd has two employees who are members of a medical insurance scheme with the VHI.
A Ltd pays the premium on their behalf directly to the VHI as an additional benefit in kind.
The gross cost of the scheme per employee is €1,000.
|TRS @ 20%||(€400)|
The company issues a cheque for €1,600 to the VHI and includes this amount in payroll costs charged to the Statement of Comprehensive Income, pays €400 to the Revenue as part of its corporation tax liability (included in the tax line in the Statement of Comprehensive Income) and takes a tax deduction in calculating its Case I/II taxable income of €2,000 for the total cost of the benefit. If A Ltd included the amount payable to Revenue within payroll costs in its Statement of Comprehensive Income, no adjustment would be required in calculating A Ltd’s taxable income as it would have already taken a deduction for the amount of the credit payable to Revenue.
When the company is filing its annual CT1 form it completes the box entitled “Clawback of Employer’s Tax Relief At Source” by entering the TRS figure of €200 × 2 = €400. It then claims the €400 as a deduction.
The employees will be liable to income tax on the BIK of €1,000 each through their payroll under current BIK regulations and they will each receive a credit for the €200 tax already paid to the Revenue by the company.
B Ltd provides its employees with the option of paying their medical insurance premiums via direct payroll deductions. B Ltd has 5 employees who have elected to avail of this arrangement. The total medical insurance premiums deducted via payroll and paid over to medical insurance providers in the accounting period ended 31 December 2018 was €4,000.
In this case, the medical insurance premium is not being provided as an additional BIK but is instead being paid out of net salary by employees – B Ltd is simply facilitating the making of the payment. B Ltd is not required to pay over the TRS credit amount to Revenue in this case and there is no adjustment required in B Ltd’s tax computation for the period.
The availability of capital allowances in respect of capital expenditure incurred on qualifying assets is covered in your Personal Taxes Manual, including the relevant legislative provisions and a discussion on the relevant case law. You will recall that a tax deduction is not available for accounting depreciation and that instead, capital allowances are granted in relation to qualifying capital expenditure. Capital allowances are typically available in calculating Case I taxable income where the assets are used for the purposes of the trade carried on by the company. The main assets which qualify for capital allowances are plant, machinery and industrial buildings. Tax legislation may also deem capital expenditure incurred on certain assets to be expenditure incurred on plant and machinery or industrial buildings. For example, certain office buildings are deemed to be industrial buildings by virtue of S.372D TCA 1997.
Capital allowances available to companies and the method of calculating annual allowances and any balancing allowance/charge following the disposal of the qualifying asset are broadly similar. However, companies are entitled to claim capital allowances on capital expenditure incurred on certain assets on which individuals are not allowed to claim such allowances. For example, this would include capital allowances on certain specified intangible assets (Section 291A TCA 1997). These allowances are discussed in chapter 6.
The concept of the tax year basis of assessment does not exist in corporation tax. However, similar to income tax, if an accounting period is less than twelve months the annual claim must be restricted to the length of the period.
Step plan for computing capital allowances:
1. Identify the cost of the asset to the company – net of grants if applicable
2. Add back accounting depreciation recorded in the statement of comprehensive income (Section 81(2)(f) TCA 1997)
3. Confirm that the asset qualifies for capital allowances – using the function v setting rules and case law as covered in the Personal Taxes Manual to determine if the expenditure incurred is “capital expenditure” and the legislative provisions setting out what capital expenditure will qualify for capital allowances (e.g. the provisions dealing with plant & machinery, industrial buildings, deemed plant & machinery and deemed industrial buildings)
4. Calculate the allowance at the appropriate rate of the cost (for each period), taking into consideration any short accounting periods
5. Deduct the allowance from the asset cost, this gives the tax written down value for carry forward to the following accounting period
6. Deduct the total capital allowances from taxable income
The rules for calculating balancing allowances/charges and how grants impact on capital allowances are all set out in the Personal Taxes Manual.
A Ltd acquires a new racking system on 1 Feb 2017 for €15,000. A Ltd prepares accounts up to 31 December each year but decides to change to a September year end from 2018.
Calculate the capital allowances claim for 2017 and 2018:
|Cost Feb 2017||15,000|
|W & T 2017 @ 12.5% SL||1,875|
|W & T @ 2018 12.5% SL × 9/12 (restricted to length of accounting period)||1,406|
Capital Allowances on capital expenditure on energy efficient equipment
To encourage “green” capital spending, capital allowances at the rate of 100% in the year they are acquired (assuming a 12 month accounting period) are available for the purchase of energy efficient equipment under Section 285A TCA 1997. These assets still have the same tax life as assets which are entitled to wear and tear allowances under s.284 and balancing allowances/charges are calculated in the same way.
It should be noted that these allowances were only available to companies to 31 December 2016 and individuals could not claim them. From 1 January 2017 individuals and companies can claim the relief.
Schedule 4A TCA 1997 lists the classes of qualifying equipment as follows:
|1. Electric motors and drives||– minimum spend €1,000|
|2. Lighting||– minimum spend €3,000|
|3. Building energy management systems||– minimum spend €5,000|
|4. Information and Communications Technology||– minimum spend €1,000|
|5. Heating and Electricity Provision||– minimum spend €1,000|
|6. Heating, Ventilation and Air Con Control Systems||– minimum spend €1,000|
|7. Electric and Alternative Fuel Vehicles||– minimum spend €1,000|
|8. Refrigeration and cooling systems||– minimum spend €1,000|
|9. Electro-mechanical systems||– minimum spend €1,000|
|10. Catering and hospitality equipment||– minimum spend €1,000|
The scheme commenced on 9 October 2008 and will apply to capital expenditure incurred on qualifying assets in the period up to 31 December 2020.
In relation to vehicles at 7, this scheme will apply in priority to the CO2 capital allowances scheme in Part 11C TCA 97. Natural gas vehicles are included in this category.
Under the legislation, in order to be qualifying energy efficient equipment, they must be included in a “specified list” of equipment introduced by Ministerial Order by the Minister for Communications, Energy and Natural Resources subject to the approval of the Minister for Finance, this list is contained in Schedule 4A.
Capital expenditure on specified intangible assets qualifies for relief under Section 291A TCA 1997 and this will be discussed in detail in Chapter 6.
(iii) Expenses which are disallowed or allowable under the “wholly and exclusively” test in Section 81(2)(a) TCA 1997
Keyman insurance covers the death/illness of an employee who is central to the management and control of the business where a sum will be paid to the company in the event of the death/illness of that employee. This is separate to death in service benefits provided by employers which are part of salary costs.
Revenue has confirmed that keyman insurance policy payments are a deductible Case I expense provided that:
(a) An employee/employer relationship exists (note – Revenue have confirmed that employee includes director)
(b) The employee does not have a proprietary interest in the business (directly or indirectly owns more than 15% of the ordinary share capital)
(c) The insurance covers loss of profit etc (revenue) rather than loss of goodwill (capital)
(d) in the case of insurance against death, the policy is short term (generally not more than 5 years although longer may be acceptable in certain circumstances) and provides only for a sum to be paid if the insured dies within a certain specified period
Any claim received from the policy is fully taxable where the company claims a deduction for the cost of the policy (or where such a deduction would have been allowed even if not claimed). It follows therefore that if the cost of the policy is not an allowable deduction then the proceeds of any claim received will be exempt from tax.
The above guidance is in Tax Briefing 11 in which Revenue confirm that it is in line with the general deductibility rule in Section 81(2)(a) TCA 1997.
Staff and director travel costs should be checked to ensure they were incurred for the purposes of the trade (s. 81(2)(a) TCA 1997). Any holiday costs should be treated as benefits-in-kind (“BIK”) in the hands of the employee or director but should still be a deductible expense for corporation tax purposes (s. 81(2)(a) TCA 1997).
Subsistence and mileage schemes should be reviewed to ensure consistency with approved civil service rates. If the rates are not consistent, the company may not be withholding the correct amount of PAYE/PRSI etc. from its employees. While rates lower than the civil service equivalents are allowable, rates in excess of these levels are taxable as remuneration in the hands of the employee.
Finance leases and operating leases
■ Ordinarily s.76A TCA 1997 states that the profits or gains of a trade should be calculated in accordance with GAAP.
■ The accounting treatment is to capitalise the asset and the effective loan in the Statement of Financial Position and take the interest charge and the depreciation charge as separate expenses in calculating the company’s profit.
■ However, if a company leases assets for use in its trade, it will be allowed a deduction for the entire lease payments in so far as they have been laid out wholly and exclusively for the purposes of the trade (Section 81(2)(a) TCA 1997).
■ As a result, for tax purposes, finance lease repayments are treated as follows:
1) The amount of finance lease interest and depreciation charges which have been included in the Statement of Comprehensive Income as a trading expense are added back in the Case I computation.
2) The company is allowed a deduction against Case I income for the total of the finance lease repayments (capital and interest element) made during the accounting period.
■ This figure is derived as follows:
|Opening leasing liabilities per Statement of Financial Position owing within one year and greater than one year||X|
|Plus: Capital cost of property, plant & equipment additions acquired under a finance lease during the accounting period||X|
|Plus: Finance lease charges expensed to the Statement of Comprehensive Income||X|
|Less: Closing leasing liabilities per Statement of Financial Position owing within one year and greater than one year||X|
|Equals: Finance lease repayments made in accounting period||X|
It is this figure which is allowed as a deduction against Case I Profits and interest and depreciation charged to the Statement of Comprehensive Income are added back.
■ Assets leased under an operating lease are not capitalised for accounting purposes so the full operating rental charge is expensed to the Statement of Comprehensive Income. This mirrors the taxation treatment and therefore no adjustments are required.
The following information is relevant for B ltd for the accounting period ended 31 March 2018:
1. 1 April 2017 Opening lease liabilities
|More than 1 year||€12,000|
2. A machine was acquired under a finance lease in October 2017. The capitalised cost of this fixed asset is €14,000.
3. Total finance lease charges (interest and depreciation) included in the accounts for the year are €7,700.
4. 31 March 2018 Closing lease liabilities
|More than 1 year||€16,000|
1. The figure of €7,700 for the finance lease charges is added back to the accounting profit in the tax adjusted profits computation.
2. The company is allowed a deduction for the total finance lease repayments.
|1.4.17 Opening lease liabilities||18,000|
|Plus: Machine acquired under finance lease||14,000|
|Plus: Finance lease charges expensed to the|
|Statement of Comprehensive Income||7,700|
|Less: Closing lease liabilities 31.3.18||(26,000)|
|Total finance lease repayments||13,700|
The focus in looking at subscriptions should be to ensure that they have been incurred wholly and exclusively for the purposes of carrying on the trade. No political donations could be deemed to be made “wholly and exclusively” for the purpose of a company’s trade, so political donations should be added back in the tax computation.
These costs must be reviewed to eliminate fees incurred for non-trading services. For example, legal fees incurred on the purchase of a new building charged to the Statement of Comprehensive Income must be added back. The fees will form part of the capital gains base cost on the subsequent disposal of the building.
Companies often have a level of expenditure below which they do not capitalise, for example, any expenditure under €5,000 is automatically treated as revenue expenditure. These will not be material for accounting purposes but must be adjusted for in the corporation tax computation.
The repairs charge in the Statement of Comprehensive Income should be reviewed for capital expenditure. If any genuine capital expenditure is found it should be added back, and the company should consider claiming capital allowances if applicable
(iv) Exempt trading or professional related income and income taxed under another Schedule or Case
The following should be deducted from the company’s accounting profits in arriving at the tax-adjusted trading profits (or loss):
■ Distributions received from Irish resident companies (Franked Investment Income or “FII”) is exempt from corporation tax (Section 129 TCA 1997). Individuals receiving dividends from Irish resident companies are taxed in full on the income under schedule F.
■ Interest on certain Government securities held by certain qualifying companies is exempt from corporation tax (Section 44 TCA 1997).
■ Grants received are dealt with in s. 317.
– Capital grants are not taxable as they are a capital as opposed to an income receipt. Equally the amortisation of capital grants to the Statement of Comprehensive Income is not taxable.
– Revenue grants are taxable apart from the following grants which are specifically exempt from tax:
■The Employment Incentive Scheme, Wage Subsidy Scheme, the Market Development Fund, the Employment Subsidy Scheme, EU Programme for Peace and Reconciliation in Northern Ireland and Border Counties, Jobs Plus Scheme (Section 226 TCA 1997)
■ Initiatives of the International Fund for Ireland (Section 226 TCA 1997)
■ Employment grants made under Section 3 or 4 of the Shannon Free Airport Development Company Limited (Amendment) Act, 1970, Section 25 of the Industrial Development Act, 1986 or Section 12 of the Industrial Development Act, 1993 (Section 225 TCA 1997)
■Profits or gains from woodlands managed on a commercial basis are exempt from corporation tax (Section 232 TCA 1997)
Income taxed under another Schedule or Case
Remember to deduct the figure credited to the Statement of Comprehensive Income in relation to the following and note the figure to be included in the tax computation under the relevant Case or Schedule:
■ Income of an illegal trade is taxable under Case IV (Section 58(2) TCA 1997)
■ Post cessation receipts are taxable under Case IV (Section 91 TCA 1997). You’ll learn more about the taxation of post cessation receipts in your Part 2 Personal Taxes: Application and Interaction module.
■ Deposit interest is taxable under Case III if no DIRT is deducted at source or under Case IV if tax was deducted at source (note – in a bank, interest income would be taxed as Case I trading income and this adjustment would not be required)
■ Irish source rental income is taxable under Case V and foreign source rental income taxed under Case III
■ Distributions received from non-Irish resident companies which are taxed under Case III (regardless of the rate of corporation tax applicable to such distributions) unless such income forms part of the trade carried on by the company
Apply principles from established case law to questions of allowable expenses/deductions
Since the legislation cannot give an exhaustive list of expenditure that is deductible against the profits of a company, it has been left to the courts to decide on many disagreements between a company and their Inspector of Taxes.
The meaning of the phrase “wholly and exclusively” in Section 81(2)(a) TCA 1997 has been considered in several cases. You will learn more about these cases in your Part 2 Personal Taxes: Application and Interaction course.
■ It is a general principle of tax that losses cannot be anticipated. For example, if a company was making losses in the current year and also knew that it was going to make a loss in the following year, it could not make a provision for the expected next year’s loss in its current year. Provisions can be created when there is a present financial obligation as a result of a past event, but not for possible future events. Under IAS 37 the company can provide for these costs if the expected cost can be reliably estimated.
■ Apart from Section 81(2)(d) which deals with provisions for repairs and Section 81(2)(i) TCA 1997 which deals with bad debt provisions, the TCA is silent as regards the question of provisions (this is acknowledged in Tax Briefing 41).
■ Accordingly, the allowability of a provision will depend on whether the provision is “wholly and exclusively” for the purpose of the trade.
■ Following that rule, the creation or increase of general provisions e.g. general bad debt provisions, general stock provisions etc. is a disallowable trading expense (nor can such a provision be created under IAS 37).
■ However, where the expense charged to the accounts relates to a specific provision for future costs, then the expense is allowable provided the provision created is considered a reasonable estimate of those future costs. This tax treatment follows the accounting treatment set out in IAS 37 and was approved by Revenue in Tax Briefing 41, following the UK tax cases noted below.
■ For example, if a company intends repairing the roof of its premises in the next 12 months at an expected cost of €7,000 and has signed a contract for this work, the creation of a provision for such repairs this year is fully allowable for tax purposes.
■ This approach has been supported by case law:
Gallagher v Jones, Threlfall v Jones STC 537 – Tax treatment follows the accounting treatment
In this case, the taxpayers entered into a lease of boats from a third party for a 24 month period. The lease provided for an initial payment, which was significant, followed by 17 monthly payments. The taxpayers sought to deduct the total lease payments in their first accounts period.
The Court of Appeal held that the way to compute profits or losses was to apply accepted principles of commercial accounting. The upfront payment for the leased asset was therefore allowed as a deduction over the period of the lease, as opposed to the accounting period in which the expenditure was incurred in line with SSAP 21 (now contained in FRS 102 Section 20) (the IFRS equivalent is IAS 17, see the Financial Reporting manual).
Herbert Smith v Honour (HMIT)  STC 173 – Tax deductibility of specific provisions
This case concerned a firm of solicitors that had included a provision in its accounts for the payment of future rents on a property that it had vacated. This was in accordance with the concept of prudence in SSAP 2, a generally accepted principle of commercial accounting at the time (FRS 102 and IAS 37 has superseded this accounting standard under current standards).
The Court held that there was no rule of law against the anticipation of liabilities, and that GAAP should be adhered to in that instance. As a result, the deduction for the amount of the provision was allowable.
■ Remember, Section 81(2)(f) TCA 1997 disallows a deduction for any capital employed in the trade or profession. This should also extend to the write-down of such capital by means of depreciation.
■ However, in some cases an allowable deduction may be taken for the depreciation of capital assets in computing taxable Case I profits.
Small (HMIT) v Mars UK Ltd.  BTC 315
■ The case concerned the computation of the trading profits of Mars UK Ltd which made confectionery.
■ The question was whether depreciation of property, plant and equipment used in the production of inventory could be carried forward as part of the cost of the inventory until it was sold. This was the treatment prescribed under the equivalent accounting standard to IAS 2 but seemed to contravene the UK equivalent of Section 81(2)(f) TCA 1997.
■ The House of Lords overturned an earlier ruling which had stated that accepted accounting practices were subordinate to tax principles and that the depreciation included in the cost of the inventory was a disallowable expense. Instead, the House of Lords held that a Case I deduction could effectively be taken for depreciation included in closing inventory valuations and that the depreciation should be added back when the inventory is ultimately sold (i.e. when the depreciation cost is reflected in the Statement of Comprehensive Income).
■ The following case considered the deductibility of fines and penalties for Case I purposes:
McKnight (HMIT) v Sheppard STC 669
In this case, fines were imposed on a stockbroker for breaches of the rules and regulations of the Stock Exchange. The stockbroker in computing his taxable profits deducted the fines and associated legal costs.
It was held that the fines were not deductible as they were ‘not connected with or arising out of the trade’.
■ As a result of the above case, a company should not be allowed to take a Case I deduction in respect of, for example, parking fines.
Costs are allowable against profits if the legislation specifically allows it or they are incurred “wholly and exclusively” for the business.
Figure 2.1. Treatment of expenses in arriving at Case I profits
2.2.Identify the disclosure notes and other sources that are relevant to the preparation of the corporation tax computation
All Irish limited companies are required to prepare accounts which conform to company law and provide a “fair presentation” of the results of the trade for the period.
It would not be possible to prepare the corporation tax computation without reviewing the company’s financial reports in detail as they will contain much of the information required in preparing the necessary tax adjustments.
This section deals with the information which is contained in the disclosure notes to the Statement of Financial Position which should be reviewed in detail when preparing the corporation tax computation.
The disclosure notes are generally given in the financial report in the same order as they appear on the face of the Statement of Financial Position.
A disclosure note is generally a breakdown under various subheadings of a one line figure in the main Statement of Financial Position. For example the figure for receivables in the Statement of Financial Position may be analysed in the disclosure note as being made up of trade receivables, general prepayments in advance (such as insurance), VAT refundable, etc.
2.2.1.Property, plant and equipment (‘PPE’) (IAS 16)
This note contains details of the assets a company uses in its trade, such as equipment, motor vehicles, buildings etc.
The note should be reviewed for the following:
|Additions:||Will the addition qualify for capital allowances?|
|Disposals:||Is there a profit or loss adjustment to the Statement of Comprehensive Income? If so, we need to extract this information from the Statement of Comprehensive Income to prepare the corporation tax computation. If we have claimed capital allowances on the asset we will need to prepare a balancing allowance/charge computation. Is it a chargeable asset or a wasting chattel?|
|Depreciation:||This needs to be added back in the computation. We need to extract this information from the Statement of Comprehensive Income to prepare the corporation tax computation.|
|Capital grants:||Under IAS 20, these will generally be disclosed separately to PPE. Depreciation will be charged on the full cost of the PPE, ignoring the grant. The grant itself will be amortised over the life of the asset (it will appear as a receipt) to the Statement of Comprehensive Income. For tax purposes, any capital allowances will generally be calculated on the net cost to the company, after the grant.|
|FRS 102 provides an option to use the accrual method (as outlined) or the ‘performance method’, where the grant is recognised when all conditions are met. In either case, the approach adopted will be disclosed in the notes.|
2.2.2.Intangible assets (IAS 38 and IFRS 3)
These are generally items such as goodwill, patents, research and development etc.
Each separate classification needs to be analysed along with a charge in the Statement of Comprehensive Income to ascertain any necessary tax adjustment.
Expenditure on items such as patents and research & development may qualify for special tax reliefs.
Expenditure on goodwill on or before 7 May 2009 is not deductible for corporation tax purposes and any charge to the Statement of Comprehensive Income is added back. After 7 May 2009, goodwill linked to a qualifying intangible asset category would be an allowable deduction for corporation tax purposes.
A retail trade is acquired by A Ltd for €1,000,000 in September 2018. The building, stock and equipment are re-valued to €800,000 and these values are reflected in the Statement of Financial Position. The difference of €200,000 is treated as goodwill and is essentially the price for buying the reputation and good name of the shop.
This cost is allowed against any future capital gain on a disposal of the shop. There are various rules under IFRS and FRS 102 as to the accounting treatment of goodwill. For tax purposes, any charges to the Statement of Comprehensive Income may be allowable if the income of the company is linked to the exploitation of intellectual property, chapter 6, (as the goodwill is linked to a qualifying intangible asset (brand name) and was acquired after 7 May 2009).
2.2.3.Inventories (IAS 2)
This note contains details of the value of inventories held by the company on the last day of the accounting period. Under IFRS, inventories are valued at the lower of cost or net realisable value.
The make-up of the asset should be reviewed to ensure that there is no general provision for obsolete or slow moving stock which has been charged to the Statement of Comprehensive Income. General provisions are not allowable for tax purposes and must be added back in the corporation tax computation. There is unlikely to be a general provision relating to inventory under FRS102 or IFRS and consequently, no adjustment should be required to be made in the corporation tax computation in respect of provisions relating to inventory. Remember though that a company may still make general provisions that fall under the materiality threshold of their auditors, so you should always ask management if any exist.
2.2.4.Current assets (IAS 1)
This note generally contains the breakdown of short term assets held by the company, mainly trade receivables, prepayments and cash.
The calculation of trade receivables should be reviewed to ensure that there is no general bad debt provision.
There is unlikely to be a general provision under IFRS as the standards impose strict rules on the creation of a bad debt reserve. Once these conditions are met then the specific provision will be (corporation) tax deductible and no adjustment will be required.
2.2.5.Current liabilities (IAS 1)
This note generally contains the breakdown of short term liabilities held by the company, mainly trade payables, accruals and bank facilities repayable within one year.
Accruals are used to include a cost in the Statement of Comprehensive Income which for whatever reason was not charged/paid during the year.
A company may rent a warehouse for €1,000 a month, therefore the charge in the accounts should be €12,000 for the year. If the landlord only invoices the December charge in January, the company will have only been invoiced for €11,000 in the year to December. When the accounts are being prepared a charge of €1,000 will be accrued to ensure that the correct rent cost of €12,000 is reflected in the Statement of Comprehensive Income.
The list of accruals should be reviewed for items which under tax law must be specifically paid in the period to be tax deductible. These are mainly pension costs and trade charges but other issues are relevant here including the PAYE implications for unpaid remuneration under s. 996 TCA 1997.
2.2.6.Lease/hire purchase payables (IAS 17)
When a company enters into a finance lease or hire purchase agreement, both the asset in question and the liabilities payable over the course of the agreement are capitalised.
Amounts repayable to the finance company within 12 months will be included in the trade and other payables note and the balance will be included under financial liabilities.
The upward or downward movement in the nominal ledgers affected by these lease or hire purchase assets (caused, for example, by interest charged, repayments made and new assets acquired) must be analysed to ensure the correct tax treatment is applied.
While the accounting treatment of finance leases and hire purchase contracts is identical, the tax treatment differs.
2.2.7.Financial Assets/Investments (IFRS 9)
These notes will show any assets that the company owns which are not directly used in its trade. Financial assets/investments are non-current assets held at either amortised cost or at fair value.
Frequently companies who have built up large cash reserves may decide to hold this cash as investments rather than return them to shareholders in the form of dividends. This could be because they wish to retain the cash earned and re-invest in it the trade at a later date.
The company may therefore invest in a range of products including bonds and shares etc.
Assets acquired for their cashflow benefit e.g., interest receivable on non-equity investments, are valued on the Statement of Financial Position at cost less transaction costs less amortisation.
The amortisation goes through the Statement of Comprehensive Income as does any gain/loss on disposal.
Equity investments are valued at fair value with transaction costs expensed in the Statement of Comprehensive Income. The gain/loss in the increase/reduction in fair value at the end of each accounting period goes through the Statement of Changes in Equity if the shares are in a subsidiary or associate.
If the equity investments are non-trading (i.e. small share holding in a company but have no influence in the decision making of the company), then the gain/loss in the fair value goes through the Statement of Comprehensive Income.
Gain/loss on disposal on fair value investments = Sales proceeds – carrying value of assets on disposal.
Any income arising from these various investments should be identified when preparing the corporation tax computation.
Also you should be aware how these investments are measured in the Statement of Comprehensive Income since an increase in fair value will not result in a tax charge (but may result in a deferred tax calculation) until asset is disposed of.
2.2.8.Investment property (IAS 40)
Investment property valued under IAS 40 is treated in a similar way to non-trading equity investments in that it is measured at fair value and any increase/reduction in fair value in recognised in the Statement of Comprehensive Income. The gain/loss on disposal = sales proceeds – carrying value of asset on disposal.
2.2.9.Related party disclosures (IAS 24) and directors’ loans (s. 239 Companies Act 2014)
These notes will include a break-down of the movement on the directors’ loan accounts between transfers to the company and from the company.
During times of poor trading/cash flow, a director may introduce funds to the company by way of loan to enable it to continue trading. These loans will be treated as a liability of the company just like an ordinary current or non-current liability would be.
A company may also make a loan to a company director, subject to very strict restrictions and penalties under company law.
From a financial reporting perspective, company law requires that the loan movement during the year is analysed as a disclosure note.
The company’s Inspector of Taxes will pay close attention to this disclosure note. There are withholding tax implications if the company is a close company and the directors owe funds to the company.
You should also examine any items in the directors’ current accounts to ensure they are correctly classed as current.
Whilst the main source of information needed to prepare the accounts is extracted from a detailed review of the Financial Statements, there are other sources which are required to prepare the corporation tax return:
Previous corporation tax return
This will provide information on the capital allowances schedule, losses carried forward, etc.
This will help ascertain whether it is a close company.
The annual directors’ report will detail any new trades commenced by the company or any major issues encountered during the year, such as branch disposals which may have a bearing on the corporation tax computation.
Discussions with directors and accounts preparation team
It is not possible while preparing the tax computation to review every single transaction during the period.
Therefore the company accountant/auditor should be asked whether he noted any items during his/her work which may have an impact on tax, especially in the area of Statement of Financial Position provisions, which they would check in the course of the accounts preparation.
The directors should be asked about whether they engaged in any tax planning during the period which may impact on the corporation tax computation.
2.3.Identify the disclosure notes that are relevant to other taxes
This section discusses the taxes other than corporation tax that can appear in a company’s financial reports.
2.3.1.Current tax assets and liabilities
Under IAS 1, a company is required to disclose its current tax assets and current tax liabilities on the face of its Statement of Financial Position. Information about the following taxes may be contained in these entries:
A typical company registered for VAT and charging VAT on its goods and services will generally submit its VAT returns and payments on a bi-monthly basis. The related VAT liability (if any) is due for payment on or before the 19th day of the following month (or the 23rd day if paying and filing through Revenue’s On-Line Service (“ROS”)). As a result, the company should have a VAT liability or refund at the end of each accounting period.
A company with a 31 December accounting year end which prepares bi-monthly VAT returns on ROS will generally have a VAT liability on its Statement of Financial Position. The VAT liability for the November/December period is not due for payment until 23 January of the following year.
Companies in a VAT repayment situation (for example, companies who deal in only 0% goods or whose clients are all VAT-exempt) will generally have a VAT receivable asset in current tax assets.
If the company is not registered for VAT, there will be no VAT liability/asset and all costs in the Statement of Comprehensive Income will be VAT inclusive.
The provider of an exempt service, such as an insurance company, must suffer VAT on any services it acquires, e.g. accounting charges. Therefore the entire cost, including VAT, is charged to the Statement of Comprehensive Income.
The PAYE payable amount in the Statement of Financial Position for a company which submits its P30s on a monthly basis should be the PAYE liability for the last month of the accounting period.
The Statement of Financial Position of a company with a December year end should include, within its current liabilities, an amount representing PAYE deducted from employees’ emoluments in relation to the month of December. This liability is payable via ROS by 23 January of the next year.
All companies on the direct debit scheme pay for the calendar year, to match the P35 reporting date, and as with VAT, pay one month in arrears.
From an accounting point of view, all withholding tax deducted from payments to third parties and owed to the Collector General are held as current liabilities in the Statement of Financial Position.
■ Income tax
Income taxes withheld during the year under s. 239 TCA 1997 are payable with the annual corporation tax liability, and will be included under current tax liabilities, less any preliminary corporation tax already paid prior to the year end.
Any relevant contracts tax (RCT) deducted during the year will be included as a current liability in the Financial Statements.
If the accounting period ends on 31 December, the liability for the Statement of Financial Position should be the taxes withheld from subcontractors in December, payable via ROS on 23rd January.
As with VAT and PAYE, the RCT liability should be reviewed for old liabilities and errors found in the preparation of the accounts, especially for cases of subcontractors paid gross when RCT should have been operated.
If the company acts as a subcontractor and is not up to date with its tax affairs, it will suffer RCT on its own receipts. This tax will be included as a current asset in the Statement of Financial Position and is refundable to the company on making a claim to the tax office, after it has filed that years CT1 return.
If the company elects to have the RCT suffered allocated against tax it owes at the year end, the Statement of Financial Position should reflect the net position.
A company owes €1,000 of VAT at the year end and has suffered €750 of RCT and it elects for an offset prior to the year end. The Statement of Financial Position should show VAT owing of €250 as a current liability.
For dividends declared and paid in the period, Dividend Withholding Tax (DWT) must be operated. Any DWT not paid at the year end will be included as a current liability.
All government departments and agencies operate this withholding tax on professional services provided to them. If a company suffers this withholding tax, it is set against its corporation tax liability for that period, subject to claiming an interim refund in certain situations.
The company can either set the tax withheld against its corporation tax liability in the Statement of Financial Position or show the full corporation tax due under current liabilities and disclose the withholding tax as a current asset.
■ Foreign taxes
If a company has foreign income it may have suffered tax on that income in the country in which the investment is held. If the company is in a position to reclaim this tax from the foreign country, perhaps under a double taxation agreement, it will be held as a current asset in the company’s Financial Statements.
If the foreign tax is available as an offset against corporation tax it will be included in the company’s corporation tax liability account, by reducing the amount of Irish tax due.
You will learn about foreign tax and how it can be relieved against corporation tax at Part 3.
2.4.Calculate the taxable profits of an Irish corporate taxpayer
The basic rule for the calculation of a company’s income is that, apart from certain specific provisions, it is to be computed in accordance with income tax principles i.e. the overall computation is broken down into the same Schedules and Cases as apply for income tax purposes and in accordance with the law applicable to those Schedules and Cases.
Section 18(2) and (3) TCA 1997 sets out the various Cases under which income is to be assessed.
Your TCA 1997 gives a comprehensive list of the case law relevant to determining the correct Case of income, the difference between capital and revenue receipts, whether a company is in fact ‘trading’ and the interaction of taxation with accounting rules.
Capital allowances and balancing allowances due to trading companies are treated as deductible trading expenses to arrive at tax adjusted profits while balancing charges are taxed as trading receipts.
In order to calculate the tax adjusted trading profit or loss and the resulting corporation tax the method outlined below should be adopted:
1. Always begin with the net profit before tax per the accounts.
2. Adjust this profit figure for all non-Case I income (e.g. investment and rental income) so as to isolate the income and expenses which relate to the trade.
3. Adjust the Case I accounting profit for tax purposes
■Addback/disallow non-tax deductible expenses.
■Deduct non-taxable income.
4. Apportion the adjusted figure at (3) on a time basis where the period of the accounts is greater than 12 months.
5. Deduct capital allowances as calculated for that specific accounting period.
6. If applicable, trading charges should be deducted from Case I trading income.
7. Add the various sources of income i.e. Case III Interest, Case V Rental Income to the above figures to arrive at the total income.
8. Adjust capital gains for corporation tax purposes so that the effective rate equates to the CGT rate. This is now the company’s chargeable gains which are subject to corporation tax.
9. Non-trade charges may be deducted against total profits in priority against higher taxed income (although the legislation does not specifically provide for this).
10. If applicable, available trading and other losses should be deducted from the related source of income before the profits are taxed.
11. Tax the total profits at the appropriate corporation tax rate or rates depending on the dates the profits were earned and the type of income (i.e. trading or non-trading).
12. Deduct any income tax already paid by the company from the corporation tax liability i.e. withholding tax deducted at source.
13. If applicable, relevant trade losses and charges may be set off against other profits on a value basis (see losses chapter).
In this section, we will use a case study to demonstrate the calculation of taxable profits.
Polo Ltd is an Irish resident company that sells spare parts for cars. It commenced to trade in 1980 and has always made up its accounts each year to 31st December.
Outlined below is the Statement of Comprehensive Income of Polo Ltd. for the year ended 31st December 2018.
|Profit before tax||122,000|
|Income tax expense||(51,000)|
|Profit for the period||71,000|
As you can see, Polo Ltd’s Statement of Comprehensive Income in the above format is of little use when calculating the company’s corporation tax liability for the accounting period. There is a significant amount of additional information which is needed for the adjusted profit computation and corporation tax computation.
The additional information required is outlined below i.e. a further breakdown of figures included in the Statement of Comprehensive Income and Statement of Financial Position.
Case study solution
1. Distribution Costs: The following items are included which may be relevant for the corporation tax computation (this is not the full list of costs):
|Depreciation on motor vehicles||12,000|
|Depreciation on plant and machinery||15,000|
|Profit on disposal of van||(4,000)|
|Loss on disposal of machine||3,000|
|Motor expenses (see note 7)||7,500|
|General provision for repairs to premises||6,000|
|Pension fund contributions (including accrual of €2,000)||20,000|
|New alarm system for premises||5,500|
2. Administrative Expenses: The following items are included which may be relevant for the corporation tax computation (this is not a full list of costs):
|Depreciation on office equipment||6,600|
|Bad debts written off||3,900|
|Bad debts recovered||(1,000)|
|Increase in general bad debt provision||6,000|
|Increase in specific bad debt provision||3,300|
|Legal fees re debt collection||4,000|
|Legal fees re proposed purchase of new premises||2,500|
|Staff expenses for Christmas party||2,900|
|Interest on late payment of PAYE/PRSI||900|
|Donations to non Schedule 26A TCA 1997 bodies||700|
|Trade subscription to ‘spare parts sellers’ association||750|
3. Finance costs: The amount is broken down as follows:
|Interest on bank overdraft||2,000|
|Interest on loan repayable 5 years||11,000|
|Finance lease charges (non-motor vehicle)||14,000|
4. Other income: The amount is broken down as follows:
|Deposit interest received (without deduction of DIRT)||6,000|
|National loan stock interest (non exempt)||10,000|
|Irish dividends received||4,000|
|1.1.18 Opening leasing obligations total||37,000|
|+ machine acquired under finance lease in 2018||12,000|
|+ finance lease charges||14,000|
|31.12.18 Closing leasing obligations total||21,000|
|Finance lease repayments for 2018||42,000|
This figure represents the deduction allowed in your computation.
6. Property, Plant and Equipment
a) Additions to Property, Plant and Equipment in 2018
|Second-hand Ford Mondeo||13,500|
|Dye machine (leased)||12,000|
|Fixtures & Fittings:|
b) Disposals of Property, Plant and Equipment in 2018
1. Disposal of van for €7,000
NBV at date of disposal €3,000
TWDV on 1.1.18 €6,250
Cost €10,000 in 2015
2. Disposal of machine for €6,000
NBV at date of disposal €9,000
This machine was leased under a finance lease - no capital allowances available.
7. Motor expenses (see note 1) can be broken down as follows:
1. Toyota Carina category E purchased in September 2015.
2. Ford Mondeo purchased second-hand in August 2018, Category A vehicle.
3. BMW purchased new in August 2018, Category D vehicle.
8. Capital Allowances
For capital allowance purposes the TWDV at 1.1.18 are
|Motor cars||7,500||(purchased 2015 @ cost €26,000, category E: allowance based on 50% of lower of new cost or specified limit - €24,000 × 50% = €12,000)|
|Vans||11,250||(purchased 2015 @ cost €18,000)|
|Plant & machinery||17,500||(purchased 2015 @ cost €28,000)|
|Fixtures & fittings||26,250||(purchased 2015 @ cost €42,000)|
Remember, you learned how to outline the steps involved in the computation of taxable profits at the start of this section. You should follow these steps in calculating the taxable profits of Polo Ltd. for the year ended 31st December 2018.
Adjusted Profit Computation for the year ended 31 December 2018
|Profit before tax per the Income Statement||122,000|
|– Depreciation on motor vehicles||12,000|
|– Depreciation on plant and machinery||15,000|
|– Loss on disposal of machine||3,000|
|– Accrual for pension fund contributions||2,000|
|– Alarm system for premises||5,500|
|– Depreciation on office equipment||6,600|
|– Increase in general bad debts provision||6,000|
|– Legal fees re proposed purchase of new premises||2,500|
|– Customer entertainment||7,800|
|– Interest on late payment of PAYE/PRSI||900|
|– Charitable donations||700|
|– Political donation||5,500|
|– Finance lease charges||14,000|
|– General provision for repairs to premises||6,000|
|– Disposal of machine on finance lease||6,000|
|– Balancing charge on disposal of van||750|
|– Profit on disposal of van||4,000|
|– Deposit Interest received||6,000|
|– National Loan Stock Interest||10,000|
|– Irish dividends received||4,000|
|– Finance lease repayments||42,000|
|– Capital allowances||21,938|
|Schedule D Case I tax adjusted profits||128,312|
Corporation Tax Computation for the year ended 31 December 2018
|Schedule D Case I||128,312|
|Schedule D Case III - Deposit Interest||6,000|
|– Loan Stock||10,000|
|Total Taxable Profits||144,312|
2.5.Justify the deduction or otherwise of expenses based on legislation and case law
Continuing on from the example of Polo Ltd, we can justify the deduction or otherwise of the company’s expenses, etc. as follows.
1. There are no statutory restrictions on the allowable running expenses of cars.
2. Van expenses are fully allowable as a tax deduction (Section 81(2)(a) TCA 1997).
3. A provision for repairs in the future is not an allowable deduction (Section 81(2)(d) TCA 1997).
4. Pension fund contributions are allowed on a paid basis (Section 774(6) TCA 1997).Therefore, the accrual included in the accounts must be added back.
6. An increase in a general bad debts provision is not allowable whereas an increase in a specific bad debt provision is allowed (Section 81(2)(i) TCA 1997). If there is a decrease in a general bad debts provision it is not taxable.
7. Legal fees relate to a capital item and so are disallowed (Section 81(2)(a) TCA 1997). Also specifically disallowed are those other items as outlined earlier in the Chapter.
8. Finance lease charges are added back but the company is allowed a deduction for total finance lease repayments for the year (Section 81(2)(a) TCA 1997). The full proceeds on the disposal of a leased asset are a rebate of rentals and are taxable as a trading receipt (see Tax Briefing 24 for a discussion of the tax treatment of finance leased assets).
9. Deposit interest received without deduction of DIRT at source and interest on national loan stock are both taxable under Case III (Section 18(2) TCA 1997).
10. Dividends received from other Irish companies (otherwise known as FrankedInvestment Income (“FII”)) are not liable to corporation tax (Section 129 TCA 1997).
11. Refer to the capital allowances computation below.
Remember, you learned how to calculate capital allowances in your Personal Tax course.
Expenditure incurred 2015
|Motor Vehicles||Vans||Plant & Machinery||Fixtures & Fittings||Total|
|Cost||12,000 (total cost 26,000)||18,000||28,000||42,000||100,000|
|Disposals (Note 4)||–||(6,250)||–||–||(6,250)|
|W & T @ 12.5% SL||1,500||1,000||3,500||5,250||11,250|
Expenditure incurred 2018
|Motor Vehicles||Vans||Plant & Machinery||Fixtures & Fittings||Total|
|W & T @ 12.5% SL||4,500||2,750||1,000||2,438||10,688|
|W & T claim for 2015 expenditure||€11,250|
|W & T claim for 2018 expenditure||€10,688|
|Total W & T claim||€21,938|
1. The additions to Motor vehicles are subject to the Co2 emissions category limits.
Ford Mondeo Category A: Specified amount €24,000
BMW Category D: Lower amount of 50% of cost or 50% of €24,000 i.e. €12,000
Total additions for capital allowances purposes in this example is €36,000
2. No capital allowances are available on the dye machine as it is a leased asset.
3. Included under Fixtures & fittings are the shelving of €14,000 plus the alarm system of €5,500 which was disallowed in the Case I computation.
4. Disposal of Van
Calculate an Irish company’s tax liability on its foreign trade
Where foreign trading income is taxed as Case III (i.e. where the trade is carried on wholly outside the State), it is computed in accordance with the same rules as Case I.
Income from foreign trades taxable under Case III should be deducted from Case I income with an add-back for any expense item relevant to the Case III activity which is included in the total expenses of the company as calculated for Case I trading purposes.
The net income after allowing for deductions should be included in the Case III section of the computation, together with other sources of Case III income.
In reality, when Irish companies have foreign trades these are actually extensions of their Irish trade and are therefore taxable as Case I. It is very unusual to see a Case III trade in corporation tax.
The tax consequences of the bad debt expense of €110,000 are as follows:
1. Bad debts written off are a fully allowable expense against Case I – no add back
2. Bad debts recovered are taxed as trading income – no deduction
3. The increase in the (general) bad debt provision of €70,000 is disallowed in full as a Case I deduction and should be added back in calculating B Ltd’s taxable Case I income.
Tadhg Ltd’s tax allowable employer pension contributions:
The two pension payments allowed are:
11 months of the ordinary monthly contribution of €10,000 (see below re January 2019 payment) €150,000 of the special contribution (see below re calculation of amount allowable).
The December 2018 contribution which is paid in January 2019 of €10,000 will be allowable in the year ended 31 December 2019, the year in which it was paid.
The special contribution amount not allowed of €150,000 (€300,000 less €150,000) will be allowed as €150,000 in 2019. For the purpose of calculating the allowable special contribution in each year of €150,000, the total amount of the special contribution of €300,000 it is compared to the normal annual contribution and not the annual contribution actually paid in the year, as the special contribution is fully paid.
Special contribution spread:
€300,000 divided by €120,000 = 2.5 years which is rounded down to 2 years. The amount allowable is therefore €300,000 divided by 2 or €150,000 per annum in 2018 and 2019.