The Inland Revenue is seeking to consult with a view to modernising corporation tax to:
Improve business competitiveness. Of interest to advisers is the intention to look closely at the removal of tax distortions that affect commercial decision-making. The expressed aim is that business decisions should be made on commercial rather than tax grounds.
Maintain fairness in taxation, especially ensuring that individual businesses pay their fair share of tax in relation to commercial profits.
One of the key drivers of tax change is the Revenue's apparent desire to tax all types of income and gains in the same way. Another is continuing the move to align taxable profits with accounting profits. The Revenue focuses on the fact that, for companies, the indexation allowance is available to reduce taxable capital gains whereas commercial accounts are generally not inflation-adjusted and are usually prepared on an historic cost basis.
The proposals would probably not have been put forward in this official consultative document if they did not have some appeal or reasonableness. But should financial advisers and product providers spend time becoming familiar with its terms since there is no guarantee that any will make it beyond proposal status?
My view is that investing time in acquiring an awareness of potential changes and developments in the market will prove worthwhile.
Relationships with corporate clients, potential clients and their other professional advisers are founded on the trust they have in you. Your demonstrated understanding and competence is a key foundation for that trust. I do not think that any of us would disagree that becoming familiar with the contents of a consultative document on the taxation of a potentially profitable sector of your client base makes sense.
Perhaps most worrying for corporate advisers is that paragraphs 2.11 and 2.12 state that: “The current regime in which only corporate gains are adjusted for inflation for tax purposes [companies do not qualify for taper relief though – my words, not the Revenue's] is likely to increase rather than reduce distortions – the deferral of taxation until realisation favours investment in assets which generate gains and indexation allowance reinforces this effect” and “It is therefore the Government's view that following a company's commercial profits for tax purposes should reduce some of the distortions arising from the present regime.”
Following the accounting principles could well mean that no indexation allowance will be given and tax on gains or losses will be assessed on a year-by-year basis where assets themselves are already dealt with on a mark-to-market basis – which is often the case where there is a ready market in the assets but less so where there is not a ready market.
The possibility of moving to a system where capital allowances are no longer given is also put forward for discussion. It is relatively well known that it is common accountancy practice to depreciate capital assets acquired by a business. Simply put, this means the value of a capital asset is reduced each year in the balance sheet. This is so even if the real or market value is increasing. An obvious example occurs with property, where the value may be written down by, say, 4 per cent a year whereas its market value may be increasing by 20 per cent a year.
What is going on? It is probably best explained after noting that there is a correlating impact on the profit and loss account. Where the depreciation reduces profits, this is the accountant's way of setting aside a reasonable amount out of profits to provide for a replacement property, it being assumed that capital equipment goes down in value at a particular rate and then has to be replaced, so it is necessary to save up out of profits each year to buy a replacement.
This is not to say that the amount deducted from profits for depreciation is actually put in a replacement property fund, just that deducting an amount for depreciation leaves less stated accounting profit for distribution. Depreciation is allowed for at different rates for different capital assets
But there is no tax relief for depreciation so, when calculating taxable profits, it is necessary to add back depreciation. One then has to consult the capital allowances legislation to determine whether the expenditure incurred qualifies for writing down allowances. It is here that we see a difference in what is allowed for under taxation and what is allowed under accounting principles.
So, financial advisers and product providers should be concerned about the:
Potential abolition of the indexation allowance.
Possible taxation of capital gains and losses accruing but not yet realised on a year-by-year basis.
Possible loss of capital allowances for tax as we move towards a system that seeks to align tax principles with accounting principles.
Designers of investment products for companies will need to carry out some modelling to determine what outcomes could emerge if the changes materialise.
Parts of this article have previously appeared in Money Marketing