Let us begin with a familiar scenario that appears to be taken out of an accountant’s training manual:
Buttercup Ltd has an Accounting Period between 1st November 2022 to 30th October 2023. On 1st February 2023, a Capital Gain of £500,000 is realised from the disposal of an asset.
How does HMRC expect Buttercup Ltd to account for this gain?
Capital Gains on Disposals of Assets/Investments - this sentence alone has a drying effect on the mouth and heavies the eyelids. Because capital gains on disposals occur so infrequently for many small companies, there is much confusion over this concept. As a result, there has been a specific piece of bad advice circulating internet forums and behind closed accountancy rooms destined to hurt numerous companies by leaving them with a larger tax bill.
However, before we delve further, let’s clarify some confusion:
WHAT IS A BUSINESS CAPITAL GAIN?
A business realises a capital gain when a profit is generated by the sale or disposal of an investment or asset. This does not apply to the sale of inventory, as they are short-term assets that constitute a part of the normal course of business.
Here are some examples of when a capital gain arises:
1. Sale of Business Assets
Assets such as property or equipment, sold at a higher price than the original cost.
2. Sale of Investments
The selling price at the point of sale is higher than the original purchase price of shares, stocks, bonds or other investment assets.
3. Mergers and Acquisitions
Appreciation of shares or assets during the event of merging with or acquiring another company.
4. Disposal of a Subsidiary or Business Division
The selling price of a subsidiary or a separate business division, exceeds the original cost of acquisition.
5. Intellectual Property Sales
Intellectual property such as patents, trademarks, copyrights or other intellectual property rights, sold at a price greater than the original acquisition or development costs.
DO CAPITAL GAINS LEAD TO CAPITAL GAINS TAX FOR COMPANIES?
NO - Capital gains realised by companies do NOT result in a capital gains tax bill as they do for individuals, sole traders and partnerships, who are subject to completing Self-Assessment forms.
In actuality, profits from the sale/ disposal of assets or investments, are treated as part of a company’s profits subject to corporation tax, rather than capital gains tax. Therefore, going back to the scenario of Buttercup Ltd, the gain of £500,000 (from disposal of an asset), would be recognised as profit subject to corporation tax, NOT capital gains tax. This means Buttercup Ltd would attain higher company profits (an increase of £500,000) and a higher corporation tax liability for tax year 2022/23.
AVOID THE CULT OF BAD ADVICE
UK companies witnessed an increase in the rate of Corporation Tax (CT) from 19% to 25% (profit depending) as of 1st April 2023. As can be imagined, this would lead to the ultimate search for answers to the question:
Does my company pay 19% or 25% when it disposes of a business asset?
It is alarming how many professional websites and accountants advised businesses to carry out disposals of assets (expected to bring in large amounts of capital gains), to be done prior to 1st April 2023, in order to benefit from only paying 19% CT.
This would lead to incorrectly prepared tax returns, as tax liabilities would be miscalculated. Additionally, this may potentially lead to operational difficulties, due to company assets being disposed of much earlier than required.
THE REALITY OF CAPITAL GAINS
This is a shocker but HMRC takes the view that gains from business disposals are NOT taxed at the rate on the day of their disposal. Rather, all gains incurred throughout an accounting period, count as part of a company’s chargeable profits and must be attributed evenly across the whole accounting period. If a company’s accounting period straddles over two different tax years (April/March) then companies would need to apportion their profits across the two tax years using a time basis approach.
Example: If Buttercup Ltd disposed of the asset on 1 February 2023, the gain of £500,000 would be apportioned across two different tax years at two different tax rates. Therefore, 6/12 of £500,000 (£250,000) would be charged at 19% CT (£47,000) to cover the period between 1st October 2022 to 31st March 2023 of one tax year. The remaining 6/12 (£250,000) is charged at 25% (£62,500) to cover the period between 1st April 2023 to 31 October 2023. Buttercup Ltd would thus receive a tax bill of £109,500 in total, for this disposal (i.e., £15,500 more tax, due to the increase in corporation tax rates).
AVOID KNEE-JERK REACTIONS
If you are one of hundreds of companies who fell for this incoherent advice, by disposing of your assets prior to 1st April 2023 (in the hopes of avoiding higher tax bills), then the first thing to do, is avoid taking any further, sudden or drastic actions. Most often we find clients in great desperation and eagerness, to undo the errors after spilling the milk. However, such knee-jerk reactions often lead to the creation of further problems.
Here are a few examples of misguided actions that companies have taken in order to remedy their mistakes:
1. Drastic Cost Cutting
Small companies may immediately resort to severe cost-cutting measures without considering the long-term consequences. This could involve staff dismissals, reducing essential resources or slashing budgets across the board, potentially hampering operations and growth.
2. Deferring Investments
In fear of the higher tax burden, some businesses have suggested halting planned investments or expansion initiatives. While it may temporarily save on immediate costs, this approach could hinder long-term competitiveness and limit potential growth opportunities.
3. Pricing Increases without Evaluation
There have been many instances when companies immediately raised prices on their products or services, to compensate for the higher tax rates. However, doing so without evaluating market demand, competition and customer sensitivity could backfire, resulting in reduced sales and customer dissatisfaction.
4. Self-Made Tax Avoidance Schemes
Unfortunately, some businesses hastily turned to tax avoidance schemes, even engaging in dubious practices to artificially reduce their tax liabilities. Such actions can lead to legal and reputational risks if they are found to be non-compliant with tax laws.
These can be avoided with a good accountant by your side.
NEW HORIZONS: DEVELOPING A MORE HOLISTIC MINDSET
It can be very beneficial to be level-headed when it comes to tax matters. Although many companies followed the misleading advice to dispose of assets before 1st April 2023, they can still follow through with particular actions to remedy their situation, rather than take drastic decisions, which could hinder business performance as well as bank balances.
1. Changing your Accounting Period
Did you know that you can change your company’s accounting period? Taking our Buttercup Ltd example, if your company disposed of assets prior to 1st April 2023 and you feel that the gains from those disposals will lead to larger corporation tax rates, then you can change your accounting period to end on 31st March 2023. This would shorten your accounting period, which may ruin your company’s performance targets, budgets and remuneration plans. However, it also means that gains from those disposals will be taxed at 19%. It is important to note that there are certain conditions, which need to be met, in order to change your accounting period as well as certain adjustments, that need to be calculated to apply the new corporation tax rates to these new periods.
2. Tax Planning
Another option is to utilise better tax planning strategies. The UK Government has given businesses and households an enviable array of tax incentives to help you reduce, defer or eliminate tax liabilities. Even if your company has made a business disposal and has achieved capital gains, it is not always the case that your company has to pay corporation tax on it. Take a popular Tax Incentive such as the Rollover Relief. This little beauty allows companies to defer capital gains tax when disposing of certain business assets and using the proceeds to acquire newly qualifying assets. Another important note to make, like any Tax Incentive, this relief has specific eligibility criteria and conditions that need to be met.
CONCLUSION
At IJB Strategia, we take a holistic approach.
We view problems from a different angle, as we specialise in government tax incentives that bridge your personal and corporate finances. We create unique and personalised solutions that assist in tax reduction, raising cheaper finances and maximum wealth extraction.
Tax Clinic is our advisory service, where we explore and problem-solve with you, a variety of tax and financially-related problems, in order to achieve solutions that produce greater value to you, your businesses and your household.
Our Tax Projects service offers you tailor-made project management. We design and undertake time-consuming and tax daunting work such as disposing assets, using methods that minimise tax liabilities.
Call us today for your tax related enquiries.
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