ACCA F6 FA09 Study Text 2010

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Paper F6 (UK)

Taxation FA2009

CHAPTER

Overseas aspects of

corporation tax

Contents

1 Overview of the treatment of foreign income and

gains

2 Consequences of establishing trading operations

abroad

3 Double taxation relief (DTR)

4 Treatment of intra-group transactions with

overseas subsidiaries

Paper F6 (UK): Taxation FA2009

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Overview of the treatment of foreign income and gains

 A company with foreign investments

 The calculation of foreign income

1 Overview of the treatment of foreign income and

gains

1.1 A company with foreign investments

If a company is UK resident, it is liable to UK corporation tax on its worldwide

profits. Therefore, any income or gains generated from holding investments abroad

(such as overseas rental income, interest from foreign bank accounts and capital

gains on the disposal of foreign investments) must be brought into the PCTCT

statement and taxed.

Foreign income must be brought into the PCTCT statement gross of any foreign tax

suffered in the foreign country. It should be included in the PCTCT statement under

the separate heading foreign income.

If a UK company disposes of a foreign capital asset, a chargeable gain is calculated

in the same way as for the disposal of a UK asset. The chargeable gain or allowable

loss is included with UK gains and losses to calculate the overall net chargeable

gains for the CAP to include in the PCTCT statement.

Foreign income and foreign gains may be subjected to local foreign income taxes or

capital taxes as well as UK corporation tax. If so, double taxation relief (DTR) is

available. DTR is provided for in the computation of the UK corporation tax

liability.

1.2 The calculation of foreign income

Foreign income is usually received by companies net of overseas tax.

The term ‘withholding tax’ (WHT) refers to any direct tax that has been deducted

from the income at source before remitting it to the UK. For example, when interest

is paid to a foreign investor, the interest actually received by the investor is the

gross interest payable less any withholding tax deducted at source.

The amount of withholding tax is calculated as: C × W/(100 – W)

where:

 C is the amount of the cash income received

 W is the percentage rate of WHT, and so

 (100 – W) is the percentage of the gross income received as cash income.

DTR is always available for WHT on any source of income or gains.

Chapter 20: Overseas aspects of corporation tax

Example

X Ltd received interest of £30,000 on its French bank account. This sum was after the

deduction of 15% withholding tax.

Required

Calculate the foreign income to include in X Ltd’s PCTCT statement and the amount

of foreign tax suffered which is eligible for DTR.

Answer

The foreign income in the PCTCT statement must be grossed up for the withholding

tax suffered.

 £

Interestreceived 30,000

Plus:Withholdingtax(£30,000×15/85)

5,294

ForeignincometoincludeinthePCTCTstatement 35,294



ForeigntaxsufferedwhichiseligibleforDTR £5,294

Paper F6 (UK): Taxation FA2009

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Consequences of establishing trading operations abroad

 The expansion of trading operations abroad

 Operating abroad via an overseas branch

 Operating abroad via a subsidiary that is resident overseas

 Operating abroad via a subsidiary that is treated as resident in the UK

2 Consequences of establishing trading operations

abroad

2.1 The expansion of trading operations overseas

Exporting from the UK and importing into the UK

If a UK company wishes to expand its trading operations overseas, it will often start

on a small scale by selling its products to existing overseas companies from its

domestic base (exporting from the UK) and/or purchasing goods from overseas

suppliers (importing to the UK).

If so, these transactions are treated as part of the trading income of the company.

The income from sales is not treated as foreign income and is not adjusted for in the

adjustment of profit computation. Similarly, the purchases and expenses are not

adjusted for as they are allowable deductions incurred wholly and exclusively for

the purposes of the trade.

Setting up trading establishments abroad

However, where a company decides to operate overseas on a larger scale by setting

up a more permanent trading establishment, it has a choice of operating:

 via an overseas branch/agency, or

 via a separate overseas company.

There are important differences in the treatment for corporation tax purposes.

2.2 Operating abroad via an overseas branch

A branch is treated simply as an extension of the UK company operations.

Therefore, all of the branch profits are assessed to UK corporation tax.

The trading income assessment is calculated in the normal way using UK tax rules.

For example, capital allowances are available on asset purchases made by the

branch. However, a separate record is maintained of the branch trading income as

opposed to the UK trading income, as it has been generated from a separate trade.

This distinction between the different sources of trading income is only important if

there are losses involved and the rules for relief of trading losses are applied.

Chapter 20: Overseas aspects of corporation tax

 Overseas branch losses can be relieved against all other income and gains in the

CAP, and can then be carried back 12 months in the normal way under s393A

(or 36 months if the extended carry back rules apply).

 However, trading losses of an overseas branch can only be carried forward

under s393(1) and set against future profits from the same trade (i.e. trading

profits of the overseas branch only, not the trading profits of the UK trade).

Overseas branch profits may be subjected to both local foreign tax and UK

corporation tax. If so, DTR is available.

It is important to note that an overseas branch is not a separate legal entity. It is not

associated and it has no group tax implications.

2.3 Operating abroad via a subsidiary that is resident overseas

If a foreign subsidiary is incorporated overseas and is centrally managed and

controlled outside the UK, it is treated as a non-UK resident company. The

implications are as follows:

 As a separate legal entity, the profits of the overseas company are assessed

according to the tax rules applicable in the country in which it is resident. UK

capital allowances are therefore not available on asset purchases.

 The subsidiary’s profits are not liable to UK corporation tax unless the profits

are remitted to the UK holding company.

 Profits remitted in the form of interest are grossed up and taxed as foreign

income in the normal way.

 Foreign dividends received in the CAP by the UK holding company are classed

as group income and are therefore ignored.

 If the overseas income is taxable both in the UK and overseas, DTR is available

for any WHT suffered.

 The overseas subsidiary is an associated company for corporation tax purposes,

therefore it will share the statutory limits even though it is not liable to UK

corporation tax.

 Losses incurred by a non-UK resident company cannot be set off against profits

of a UK company.

 Chargeable gains will arise on the transfer of capital assets from the UK

company to the overseas company.

2.4 Operating abroad via a subsidiary that is treated as resident in the UK

If the subsidiary is incorporated overseas, but is centrally managed and controlled

from the UK, it is treated as a UK resident company and is liable to UK corporation

tax in the normal way, via a separate corporation tax computation.

Paper F6 (UK): Taxation FA2009

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Double taxation relief (DTR)

 Overview of double taxation relief

 Treaty relief

 Unilateral relief

 The effect of deductions from total profits

3 Double taxation relief (DTR)

3.1 Overview of double taxation relief

A UK resident company may suffer both UK corporation tax and overseas tax if it

has income from foreign investments or income from trading overseas. Double

taxation relief (DTR) is available to mitigate this double charge to tax.

3.2 Treaty relief

Treaty relief applies where the UK has a specific agreement with the country

concerned. The detail of any particular treaty is not examinable, but an awareness is

required of how treaty relief is given.

Typically, a DTR treaty will contain the following:

 exemption clauses whereby some income and gains are taxable in one country

but exempt in the other

 an agreement on the level of taxation to be applied to some types of income in

both countries, and

 a credit relief clause: this usually specifies that relief should be given in

accordance with the unilateral relief provisions.

3.3 Unilateral relief

In practice, unilateral relief applies where no treaty agreement exists or a treaty

specifies that unilateral relief should apply. Examination questions will only require

DTR to be given by unilateral relief.

To calculate unilateral relief, foreign income is included in the PCTCT statement

gross of any WHT suffered.

The amount of unilateral DTR is then calculated as the lower of:

(1) overseas WHT suffered on the foreign income, and

(2) UK corporation tax payable on that source of foreign income (calculated at the

effective rate of UK corporation tax for the company receiving the foreign

income).

Chapter 20: Overseas aspects of corporation tax

In other words, DTR is the lower of the overseas tax suffered and the UK tax on the

income.

Unilateral relief is given as a tax credit relief, in other words by deduction from the

UK corporation tax liability.

If there are several sources of foreign income, a separate DTR calculation is required

for each source.

Example

Y Ltd prepares its accounts to 31 March each year. It has no associated company and

has not received any dividends. It has supplied the following information for the

year ended 31 March 2010:

 £

TradingprofitfromUKoperations 125,000

Tradingprofitfromove rseasbranch(afterWHTof15%) 21,250

RentalincomefromapropertyinGermany(afterWHTof25%) 56,250

Required

Calculate the corporation tax payable for the year ended 31 March 2010.

Answer

YLtd:Corporationtaxcomputation



Yearended31March2010

Total

profits

UK

profits

Overseasincome

Branch

profits

(WHT15%)

Rental

income

(WHT25%)

 £ £ £

Tradingincome(W1) 150,000 125,000 25,000

Foreignrentalincome(W1) 75,00075,000



–

–––––

–

––––––––––

–

–––––––––––––––

–

–––––

–

––––––––––––––––––––––––––

–

–––––

–

–––––––––––––––––––––––––––– –––––––––––––––––––––––––––––––––

–

PCTCT 225,000 125,000 25,000 75,000



–

–––––

–

––––––––––––––––––––––––––

–

–––––

–

––––––––––––––––––––––––––

–

–––––

–

–––––––––––––––––––––––––––– –––––––––––––––––––––––––––––––––

–

Corporationtaxliability=(£225,000×21%)=£47,250

Thisisthenallocatedtoeachsourceofincomeat21%

Corporationtaxliability 47,250 26,250 5,250 15,750

DTR(W2) (19,500) n/a (3,750) (15,750)



–

–––––

–

––––––––––––––––––––––––––

–

–––––

–

––––––––––––––––––––––––––

–

–––––

–

–––––––––––––––––––––––––––– –––––––––––––––––––––––––––––––––

–

Corporationtaxpayable 27,750 26,250 1,500 Nil



–

–––––

–

––––––––––––––––––––––––––

–

–––––

–

––––––––––––

–

–––––––––––––

–

–––––

–

–––––––––––––––––––––––––––– –––––––––––––––––––––––––––––––––

–

Paper F6 (UK): Taxation FA2009

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Workings

(W1) Overseas income

Gross income is calculated as the cash income multiplied by a factor 100/(100 – W)

where W is the rate of withholding tax as a percentage.

Branch profits (£21,250 × 100/85) = £25,000

Rental income (£56,250 × 100/75) = £75,000

(W2) DTR

 Branch

profits

Rental

income

Lowerof £ £

(a)Overseastaxsuffered

Branch:(£25,000‐£21,250) 3,750

Rentalincome:(£75,000‐£56,250)18,750

(b)UKtaxonthatsourceofforeignincome 5,250 15,750

Note: DTR must be calculated separately for each source of foreign income.

3.4 The effect of deductions from total profits

If applicable, a company may deduct from total profits:

 loss relief claims under s393A

 group loss relief

 Gift Aid donations.

However, loss relief brought forward under s393(1) can only be set off against

profits of the same trade.

If the company has both UK and foreign income, it is necessary to decide the

particular source of income against which any deductions from total profits are to

be made, as DTR requires a separate calculation of the UK tax relating to each

source of foreign income.

The tax legislation does not specify a strict order of set-off, so the company can

choose to set off deductions in the way that will maximise the benefit of DTR.

To maximise the DTR available, it is advantageous to set off any deductions in the

following order:

 UK income first, then, if necessary

 foreign income, starting with the source suffering the lowest effective overseas

rate of tax.

Chapter 20: Overseas aspects of corporation tax

Example

Z Ltd prepares its accounts to 31 March each year. It has no associated companies

and has not received any UK dividends. It has supplied the following information

for the year ended 31 March 2010:

TradinglossfromUKoperations (37,500)

Tradingprofitfromove rseasbranch(afterWHTof15%) 21,250

RentalincomefromapropertyinGermany(afterWHTof25%) 56,250

Interestincome 22,500

Required

Calculate the corporation tax payable for the year ended 31 March 2010 assuming

loss relief is claimed as soon as possible.

Answer

ZLtd:Corporationtaxcomputation,yearended31March2010



Total

profits

UK

profits

Overseasincome

Branch

profits

(WHT15%)

Rental

income

(WHT25%)

 £ £ £

Tradingincome(W1) 25,000 Nil 25,000

Interestincome 22,500 22,500 

Foreignrentalincome(W1) 75,00075,000



–

–––––

–

––––––––––––––––––––––––––

–

–––––

–

––––––––––––––––––––––––––

–

–––––

–

–––––––––––––––––––––––––––– ––––––––––––––––––

–

––––––––––––––

–

 122,500 22,500 25,000 75,000

s393Alossrelief (37,500) (22,500) (15,000)



–

–––––

–

––––––––––––––––––––––––––

–

–––––

–

––––––––––––––––––––––––––

–

–––––

–

–––––––––––––––––––––––––––– –––––––––––––––––––––––––––––––––

–

PCTCT 85,000 Nil 10,000 75,000



–

–––––

–

––––––––––––––––––––––––––

–

–––––

–

––––––––––––––––––––––––––

–

–––––

–

–––––––––––––––––––––––––––– –––––––––––––––––––––––––––––––––

–

Corporationtaxliability:

(×21%) 17,850 Nil 2,100 15,750

DTR(W2) (17,850) n/a (2,100) (15,750)



–

–––––

–

––––––––––––––––––––––––––

–

–––––

–

––––––––––––––––––––––––––

–

–––––

–

–––––––––––––––––––––––––––– –––––––––––––––––––––––––––––––––

–

Corporationtaxpayable Nil Nil Nil Nil



–

–––––

–

––––––––––––––––––––––––––

–

–––––

–

–––––––––––

–

––––––––––––––

–

–––––

–

–––––––––––––––––––––––––––– –––––––––––––––––––––––––––––––––

–

Workings

(W1) Overseas income

Branch profits (£21,250 × 100/85) = £25,000

Rental income (£56,250 × 100/75) = £75,000

Paper F6 (UK): Taxation FA2009

(W2) DTR

 Branchprofits Rentalincome

Lowerof £ £

(1)Overseastaxsuffered

Branch:(£25,000‐£21,250) 3,750

Rentalincome:(£75,000‐£56,250)18,750

(2)UKtaxonthatsourceofforeignincome 2,100 15,750

Note: If the remaining loss of £15,000 had been set off against the rental income

rather than the branch profits, there would have been £1,500 of corporation tax

payable relating to the branch profits. (i.e. £25,000 x (21%-15%))