1 Introduction
1.1 When negotiating tax covenants it is helpful to have an understanding of some of the basic mechanics of tax computations as prepared and submitted to the tax authorities: many of the issues raised relating to tax covenants spring from the corporation tax computations. 1.2 Section 9, ICTA stated that the amount of income for corporation tax purposes should generally be computed in accordance with income tax principles. This meant that a trading company was taxed under Sch. D Case 1 in respect of trading profits and that rental income was taxed under Sch. A. This structure of corporation tax was therefore built on the elderly foundations laid down for the raising of taxes from the gentry in order to fund the Napoleonic wars. The legislation has now been reorganised, with the introduction of CTA in 2009. There is no longer the use of income tax as the main reference point: section 35 CTA states that profits from a trade are subject to corporation tax and section 46(1) states that such profits must be calculated in accordance with generally accepted accounting practice. 1.3 Section 8(5), CTA (formerly section 8(3), ICTA) provides that corporation tax shall be computed by reference to accounting periods and shall then be apportioned between financial years. Financial years are years running to 31 March in each year. Therefore, if a company has a year end of 31 July, its profits will be apportioned: 8 months will be related to the financial year which ended on the previous 31 March, and the remaining 4 months will be apportioned to the following financial year. The reason for this apportionment is that any changes in rates of corporation tax are effective from 1 April. 1.4 A number of these apportionments will be on a time basis. There are exceptions to this, notably capital expenditure and capital gains, which are allocated on an actual basis. 1.5 Sections 9 and 10 CTA (formerly section 12, ICTA) sets down the rules for the starting and ending of accounting periods: the general rule is that the accounting periods run to the accounting reference date as chosen by the Company, but there are some exceptions to this rule: if an accounting period exceeds 12 months, it is broken down into successive periods of 12 months and then the balance; an accounting period also comes to an end when a company begins or ceases to trade, when it ceases to be within the charge to corporation tax and when a period of administration comes to an end. 1.6 Profits of a company up to £300,000 per year are taxed at the lower rate of corporation tax. For profits between £300,001 and £1,500,000 the profits are taxed at a marginal rate. The effect of this marginal rate is that profits of £1,500,000 are taxed at the main rate of corporation tax. The marginal rate is therefore rather higher than the full rate. This is necessary so that the average rate can steadily increase from the small companies rate to the full rate. This can be demonstrated by an example: Wetherden Systems Limited makes a taxable profit of exactly £1,500,000 in the year to 31 March 2009.
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