CT2 Not so FAQ

[Korach]

I really enjoy my ActEd notes, but now and then I'm left scratching my head...

The summary for chapter 3, under Corporation tax lists the adjustments of the accounts to reach taxable profit. It says to deduct gross franked investment income (gfi). That's fine, but then....

It defines gfi as dividend received plus attaching tax credit!
So the tax credit would be deducted from income to get taxable income?
I would have thought it would be deducted from the tax charge!

At the end of chapter 4, examples of cases where warrants are given include: as compensation for creditors in case of bankruptcy. I assume that creditors don't want options for shares in a bankrupt company, so what does it mean?

I would appreciate your answers... and your not so FAQs.

 

[Dha]

At the end of chapter 4, examples of cases where warrants are given include: as compensation for creditors in case of bankruptcy. I assume that creditors don't want options for shares in a bankrupt company, so what does it mean?

It's funny you should mention that cos when I was doing CT2 that wrecked my head. I emailed the ActEd tutor, and they said:

Good point! I'm not sure. Perhaps, the company would not be able to pay its creditors but if the creditors were happy not to ask for immediate payment, (with the bribe of share options) the company could continue to trade. (?) I'll have to think more on this!

That's probably as much help to you now as it was to me then!

 

[Korach]

Not so FAQS - still confused

Thank you Dha, and thank you Margaret Wood (CT2 FAQ) for your answer on warrants on bankrupt companies - now it makes sense!

I'm still about confused about the tax credit, though.

Here's the FAQ answer:

Question

I don't understand why gross franked investment income (dividend income plus 10% tax credit) is deducted from accounting profit before tax when calculating corporation tax.

Answer

In the UK, companies do not pay corporation tax on the net dividend income (ie actual dividend income)received from other companies. This is because the dividend has been paid out of post-tax profit. (See question above for an explanation of the imputed tax system.)
However, when drawing up accounts, companies must record the gross dividend income received (ie including the tax credit) as taxable profit and then show the tax credit as tax paid. Companies do not pay corporation tax on gross dividend income so it has to be deducted from other taxable profit before corporation tax is calculated.
For example, suppose a company earns £100 from operating activities and £9 net dividend income. We know it will pay 30% corporation tax on the £100, ie it will pay £30 corporation tax, and its post-tax profit will be £79.
In the accounts, the company will show its taxable profit as £100 + £10 (ie the gross dividend income) = £110. The £10 gross dividend income will be deducted so that the company pays corporation tax on the £100. In the tax section, the records will show that the company has paid £31 tax, ie £30 on the operating profit and £1 on the dividend income. The company will therefore record a post-tax profit of £79.

My problem is this:
"the company will show its taxable profit as 110.... the company pays corporation tax on the 100"

It seems to me that only the 100 is taxable! Also, where did 110 come from? Supposedly the company received only 109. So what does that 110 mean, I mean, in reality? And if you tell me that that extra pound is money saved from the tax bill, there is no saving here!

"In the tax section, the records will show that the company has paid 31 tax"
But we know that the tax bill is only 30! So how can the company claim to have paid 31? (And how am I going to know how much cash the company has!) What's for sure, the company only had to pay 30, since only 100 was taxable, so there is absolutely no benefit gained from the tax credit, except that the company can brag that it gave 31 to inland revenue instead of the actual 30?!?!

Looking forward to enlightenment!