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QA bank question 2.20

B

bij_30

Member
Question 2.20
The published accounts of a United Kingdom manufacturing company for a particular year showed the following:
(a) operating profit of £5,000,000
(b) 10% depreciation on assets valued at £1.5 million
(c) interest of 5% on a loan stock with a nominal value of £2 million
(d) entertainment expenses of £300,000
(d) net investment income of £180,000 from dividends on ordinary shares of other United Kingdom companies.
Assuming that:
1. the tax authority calculated that the capital allowances for the year came to £400,000
2. the tax authority judged that only half of the company’s entertainment expenses were “allowable”
3. the first ¾ of the accounting year fell into a financial year in which corporation tax was 31%, and the remainder into a financial year in which corporation tax was 30%, calculate the company’s total corporation tax bill for that accounting year.

The Answer is as:
Operating profit 5,000,000
add back depreciation 150,000
add back half of entertainment expenses 150,000
deduct capital allowances 400,000
deduct interest paid 100,000
Adjusted profit 4,800,000

In the UK, companies pay no more tax on the dividend income received.
Therefore, the company’s corporation tax liability
= (¾ × 0.31 + ¼ × 0.30) × 4,800,000
= £1,476,000

In this question why are we not considering net investment income adjustment before calculating tax. Shouldn't the net investment income be considered as a part of finance income and be adjusted to operating profit before arriving to net profit before tax?
 
Hi

For most sources of investment income you'd be correct - they would be included in the company's income to be taxed.

However, they're not included in this case as the investment income is all dividend income. (Section 2.3 of Chapter 3 is the Course ref for this)

Hope this helps
Lynn
 
Thank you Lynn. This helps!

As dividend incomes are franked investment income they are already taxed to the company from where they come in and the investor gets a tax credit. Right?
 
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