Free Law Essays - The 'Delta Group' And Its Shareholders
A) The 'Delta Group' of trading companies comprises the parent company, Delta Ltd (DL) (which manufactures pharmaceuticals), and its wholly-owned sales distribution subsidiaries, Alpha Pty Ltd (AL) and (Beta) Ltd (BL). During the financial year 1 April 2004 - 31 March 2005, DL has trading profits of 3.5million pounds; AL has incurred a trading loss of 750,000 pounds (equivalent). BL has made trading profits of 2.4million pounds out which the company intends to pay a dividend of 800,000 pounds to DL.
Advice:
Taxable income in the UK stems from the realization convention, which includes all profits from the point of sale. This means that any profits from sales on credit are included in the profits. The tax year in the UK runs from the 1st April through to the 31st of March, therefore the 1st April 2005 is a new tax year. Also any interest that is paid to outside businesses is tax deductible. In the same sense dividends paid to the owners post-tax and therefore not tax deductible. The Delta Group in respect to the profits of DL's 3.5 Million and BL's 2.4 million are wholly taxable because they are profits of the two respective companies. The question arises whether as a group the Delta Group can write off AL's loss of 750,000. If a single company has losses it can write it off against any profits of the same tax year, this is only in the case of trading losses where the rules are contained within the Income and Corporation Taxes Act 1988, s. 393. Therefore as a group these losses could be written off the profits as long as all are domestic tax residents. The group under taxation law is defined as a group of companies, which are at least 75% owned by another company in the group or a consortium of owners of at least 5% each. In this case this requirement is satisfied as DL wholly owns the subsidiaries of AL and BL. The way that this loss is written off is that one member of the group surrenders its losses to be set against the profits of another member, i.e. this other member claims the loss. Also it needs to be noted that payment received from a tax loss is not tax deductible for the claimer or taxable for the surrender. It is just simply used to balance out profits and losses in the group. In respect to the group corporation tax does not apply to the group's profits as a whole as each company/subsidiary in the group has already been subject to this tax. To apply further corporation tax would double the tax liability, therefore creating an inequity in the law. In respect to the dividend that is paid by BL to DL there are rules surrounding the dividend's taxation. The dividend has already been subject to corporation tax with respect to BL therefore the dividend is not taxable when transferred to DL. This income again is following the rules of equity that govern transfers between subsidiaries in respect to profits and losses, as well as the transfers of assets between subsidiaries. The difference with dividends is that it non-taxability applies to any case where it is paid to any company where the paying company has been subject to corporation tax. This dividend would be subject to a tax credit and under UK law is called 'franked' investment income; whereas if a company is paid gross receipts it is 'un-franked' income and corporation tax is applicable. Therefore DL's income of 3.5 million is fully taxable, as is BL's; however AL may transfer its loss to one of these companies in the group. Finally, the dividend that DL has received from BL is non-taxable as it has already been taxed.
B) The issued share capital of DL is held as follows: George, Dick, Donald, Al, Hiliary and Condi (who are acquaintances but are not related) each owns 5%. They are all married and each spouse owns 1%. George's nephew Tony, Al's uncle Samand Hiliary's friend Bill each own 6%. Of the remaining shares 25% are by various members of the public, none with a shareholding greater than 1%and the final 15% is held by Omega plc, a public company whose shares are listed on the London Stock exchange and are included in the FTSE 100.
Advice:
In respect to the income that comes from the shares of DL one needs to determine what category it falls under in respect to personal income tax. The most basic section of British income tax falls under the heading of PAYE, which is Pay as You Earn. Share capital is not employment income and not part of this calculation. The British income tax system falls under a schedule system, which was introduced back in 1803 with five schedules - A, B, C, D and E. A, B, and C are less important areas of income tax because respectively they cover; some types of income from property; incomes from commercial woodlands, which was finally abolished in 1988; and annuities and interest payable out of public revenue. The main schedules are D and E, which are incomes from; trades, professions, businesses, property and other annual profits; and employment. Prior to further examining the liabilities that the shareholders of DL's share capital owe to the UK's tax regime, which falls under Schedule D, this discussion will turn to the subject of withholding tax at the source which has been uniquely engineered by the UK's taxation system. The notion of withholding tax at the source is very old in the UK and as Soos indicates dates back to 1512. The most prevalent form today is the Pay-As-You-Earn system which deducts tax on one's pay cheque so no income tax or National Insurance contributions are owed for employment at the end of the tax year. Another example is the paying of dividends between companies and their owners because they have already been subjected to corporation tax and under equity's maxims justice needs to be achieved. In respect to taxation there is no extra charge for investment income today; however prior to 1984 there was a surcharge. In addition to those married individuals there is no tax breaks for the income from the share capital based on marriage because this was abolished in 1990. Under Schedule D there are six classes and the share capital will either apply under miscellaneous profits (class vi) or interest not taxed at source (class iii). The question is whether each individual's income from the share capital is considered to be taxed at the source. Under the corporation tax system any dividends paid to individual owners are considered to be non-taxable because they are taxed at the source via corporation tax; however this is not the case with profits from investments, i.e. a dividend is different from a profits from share capital because in essence every shareholder is an owner but to not tax them seems unfair, especially when the income is so easily earned. Whilst, on the other hand, a person who works for their income is taxed; therefore a shareholder is different from an owner in this respect and liable for taxation under Schedule D, unless the profits from the shares are liable to personal income tax at the source and then the tax has already been paid. Therefore the profits from that are received from their shares will be subject to tax, although each year on shares as with tax from employment there is so much that is exempt from tax.
C) In May 2004, the DL board of directors agreed to allow Donald's daughter JoAnne to live in an apartment in the Barbican which the company holds on a long lease. The annual rent, maintenance and insurance for the apartment is 24,000 pounds of which 5000 pounds is reimbursed by JoAnne. The DL board has also decided to make an interest-free loan of 250,000 pounds to Dick who wishes to purchase some land for development.
Advice:
The apartment has to be considered an expenditure of the company and ones has to determine if it is a tax deductible expenditure. Also a second question arises which is if the apartment is a tax deductible expenditure from the profits of DL is the 5000 pounds received from Jo-Anne classed as a profit or taken from the costs of the apartment. The problem with this apartment is that it may not be tax deductible because of the case law surrounding tax deductible expenditures of companies, which is basically the same whether it is in respect to corporation tax, business expenditures or personal tax expenditures. As with Schedule D of personal income tax the allowances for tax deduction for corporation tax are under the Taxes Act 1988, s. 74. Section 74 holds that any expenses that are not wholly and exclusively laid out for the purposes of the trade are disallowed. In the case of CIR v Rutledge the classification of what a trade is was defined where a single transaction of buying and selling is considered trade. In the case of Pickford v Quirke it was held that buying businesses and making profits from asset stripping was a trade, even if only an isolated case. In respect to wholly and exclusively in the case of Norman v Golder it was held that doctor's bills were not expenses but an advantage to the taxpayer as a person. Also in the case of Bowden v Russell and Russell it was held that a solicitor traveling to the USA to go to a conference and combine this with a holiday because the holiday stops it being exclusively for his profession. Yet, the plane trip which cost the same price would have been tax deductible if there was no holiday. Therefore this illustrates the strict nature that the courts define Section 74. In respect to corporations and corporation tax there has been further definition on what a trade and wholly and exclusively. In the case of Strong and Co Ltd v Woodfield it was held:
It is not enough that the disbursement is made in the course of, or arises out of, or is connected with the trade it must be made for the purpose of earning profits.
The facts in this case are interesting because in the interests of equity it does not seem fair where the damages paid to a customer when a chimney fell on him was disallowed. It was also held in the case of Smith Potato Estates Ltd v Bolland it was held that any costs from a tax appeal were not tax deductible. Also this creates problems with the individuals who mix business and personal expenses. The case of Sharkey v Wernher illustrates this where Wernher transferred horses from her taxable stud to her non-taxable stables, which caused the decision that the horses were a profit and taxable against the stud; however their cost was non-tax deductible. This results in an unfair decision. If we now apply this to the situation of the apartment we will see that the case of Sharkey v Werhner is a key case where the costs of the apartment are not tax-deductible because of the personal the rent and no profits is made rather a huge loss; however along the same line the money that DL receives from Joanne will be taxable as money from a property.
If we now turn to the interest free loan that DL paid to Dick as this expense is making no profit, i.e. it is interest free it does not follow the formula of Strong and Co, i.e. in the pursuit of profit therefore it is not a tax deductible expense either, unless it can be shown that the property development will bring profit to DL.
D) on 1 April 2005, DL will acquire a wholly-owned sales distribution company, Epsilon Ltd (EL) which is incorporated in the Cayman Islands. All DL pharmaceutical products for the North American market will be distributed by EL - DL will sell its products to EL at cost price only, instead of cost +50% which is the usual manufacturers mark-up. This will allow EL to undercut similar products made by competitors (whose initial cost price is higher) and will maximize profits in the Cayman Islands where there is no corporate tax. It is anticipated that EL will have profits of 5 million (equivalent) in the 2005 tax year.
Advice:
The first note that has to made, is that any liability for DL and possibly EL, if determined a tax resident of the UK will be in the tax year starting April 2005. EL is incorporated in the Cayman Islands therefore does this make it a Cayman Island tax resident and not a UK tax resident? The question is that because it is owned by DL and therefore the Delta Group is it liable under UK tax laws? The answer is that it is a Cayman Island tax company however if money is paid via dividend from EL to DL then it is liable to corporation tax as this is 'unfranked'. Therefore it is not subject to the same exceptions as the UK companies in the group, this is the same for assets and for group losses because it is not a UK company it is not applicable for the same relief. Therefore there is a problem with DL selling its products to EL at the cost price because it is not making profits from these costs, then these costs may not fall in line applicable costs for tax deductions. If we consider the case of CIR v Rutledge again it was held that buying and selling was considered to be trade; however in the case of Pickford v Quirke it was added that making profits were important to the definition of buying and selling in respect to the definition of trade. Finally, the case of Strong & Co made the making of profits from the buying and selling or other subsequent actions a key factor in the definition of trade. Therefore this means that if the selling of a particular good to another company is not for the purposes of making a profit means that this is not a case of trade. This is problem that DL has when selling its goods to EL, because EL is not a UK company and could not benefit for the transfer of assets where the money that DL receives from EL is not taxable. The problem is that this money is taxable because it is a company outside of the UK group of companies. In addition the question, as with the Wernher case, is whether the sale of goods to EL will never result in a profit for DL and therefore cannot fulfill the definition of trade in respect to a tax deduction. If the cost of these goods did receive a profit or the possibility of a profit the result would be a tax deduction, as this is an impossibility in the case with EL then it is highly unlikely that it would be allowed as a tax deduction, because the sale at cost is for purposes other than profit for DL. The reason is to bring higher profits to the group as a whole; however if it was a UK company it would be able to transfer these assets and this would be applicable; but having EL as a Cayman Island company does cause problems in tax allowances and the taxing of the money received from selling the goods at cost for DL within the UK tax system. Along the same lines any dividends paid from EL to DL will be taxable because they are 'unfranked' because there is no system of corporation tax in the Cayman Islands. Therefore before purchasing the company in the Cayman Islands the full effects of having a company registered outside the UK has to be weighed up because the fact that there is no corporation tax in the Cayman Islands may in the long term turn out to be more expensive, especially in respect to the loss of tax-deductions and the costs associated with the taxability of money DL receives from EL in the form of dividends and cost price of goods.
2 - AL on whether the company is UK tax resident:
Background:
Although DL and BL are incorporated in the UK, AL is incorporated in Australia and the company's head office is located in Sydney. While the day-to-day running of the company is conducted in Sydney, all major long-term decisions affecting AL are made by the directors of DL in London - these decisions are then issued to as 'directives' to the AL board of directors who always carry them out.
Advice:
If one considers director's duties and liabilities this may shed some light on whether AL is an Australian company. If it is an Australian company then it cannot transfer its losses over to a UK company in the group as was indicated in the first question. Also the problems that EL and the Delta Group will encounter would also be encountered by AL. There is one significant difference between EL and AL which AL is already part of the group and all the controlling decisions are made by director's based in the UK. Therefore if one considers what the directors are then it may be easier to determine if AL is a UK or Australian tax resident. The general duty that the director holds is to the company, which has been established through the law of equity, which will be further discussed in the next section. In relation to contracts that personally benefit the director under contract law the company can make it avoidable as it is in breach of the basic duty that the director holds, which is implied in the present Company Acts. However there is the provision that if the director declares to the board his personal interest, at the soonest possible time, then if the board approves the contract then this contract is valid. In respect to securities listings, crime and environmental breaches made by a company they can directly impute back to the company if it can be shown that the breach was a direct consequence of the controlling mind of the company. For example, the FSMA 2000 also deals with the expansion of the insider trading laws to include all legal entities, include companies and corporations. Therefore there is the possibility that the company can be prosecuted because it is liable for its managing director's actions, because all though this criminal act requires mens rea all that the prosecution has to show is that the illegal act was done by the controlling mind of the company. Therefore in respect to paying tax it would make sense if the controlling mind of the company is present in the UK then the company is not an Australian company but a company of the UK where its physical presence is in Australia. Therefore this would make AL a UK tax resident and therefore liable for corporation tax. Yet, this also benefits BL and DL where the loss of AL can be claimed by them and equalization for profit and tax purposes of the Delta group can occur. In fact it is less that AL is an independent subsidiary, as with EL. Rather it is a branch in Australia where the directors, which are more like top management, follow the directions from DL's board of directors. Therefore as with English law if the real set up is not independent companies but a subservient sector of a company that is located elsewhere the tax law will consider AL as a UK tax resident as in reality it is directly controlled by DL. This is very similar to the approach taken by the Inland Revenue in respect to persons who argue they are self-employed but in reality are employed by a company and fall under the less favorable system of Schedule E's PAYE. This is because the courts will determine if a contract of employment is present rather than a contract of services then Schedule E will apply, because the real situation is this regardless of the make-up of the contract. Therefore along the same line of thinking the Inland Revenue will class that AL is a tax resident of the UK because it is not independent of DL, but a branch of DL that has no independence from DL. In order for there to be autonomy the decisions of DL's directors should not be followed like orders, rather a system of independent decision making and running needs to occur.
3 - Nicole, who has learnt from the Inland Revenue that it considers her to be UK tax resident for the year of assessment 2004/2005:
For the past five years, Nicole, AL's managing director who has always lived in Sydney, has spent an average of four months every year in the UK, partly on company business and partly on vacation.
Advice:
The first consideration is that AL is a UK tax resident; however this does not mean that Nicole is, because her main residency is in Australia. Yet the problem is that for on third of the year Nicole is resident in the UK and working for a UK company. The first question is the nationality of Nicole and can she work freely in the UK, if not then it would be unjust to class her as a UK tax resident. Also the other question to ask is whether she a tax resident of Australia, if so she cannot be held as a tax resident of both countries as this would inequitable. Also the amount of time she spends on holiday in the UK needs to be carefully delineated, i.e. leisure time cannot be held against a resident of another country to make them a tax resident of the UK. Also the amount of time that Nicole spends on business needs to be defined, because even if it is two three months it is normal for non-tax residents to do business in the country for that period of time especially when the company is directed from the UK. Therefore it is necessary for Nicole to ensure the reasoning for her classification of UK tax resident, if this purely based on her 4 month stays she need to ensure that her holiday time is separated from her business time. Also if she is paying taxes in Australia this needs to be proven to the Inland Revenue because to hold her liable in two countries for the same employment is inequitable. In addition her history as an Australian tax resident and previous years with exactly the same circumstances as an Australian tax resident will probably get the Inland Revenue to change their classification of Nicole as a UK tax resident.
4 - George on any possible capital gains tax consequences of the following transactions:
Background:
George rents a flat in Canary Wharf where in lives during the week. George also owns a house in a Somerset village which he purchased for 250,000 pounds in 1985 and where he spends some weekends. The house had a large garden of two hectares and in June 2004 George sold half the garden to a developer for 300,000 pounds and then in January 2005 sold house and remaining garden for 650,000 pounds. George had an antique oak dining table and 10 matching chairs which he had purchased for a total of 4000 pounds in 1988 (table 2000 pounds; 10 chairs 2000 pounds). In September 2004 George sold the ten chairs for 850 pounds each to Lucky John, a local antique dealer and then sold him the dining table as well for 6000 pounds in November 2004.
Advice:
George will be liable for Capital Gains Tax for the house and garden bought in 1985 and sold separately, the garden in 2004 and the house in 2005. The total that George has profited is 700, 000 (950,000 - 250,000); however the 700, 000 will not all be subject for Capital Gains Tax there will be allowance for inflation in respect to the indexation allowance. The interesting aspect of capital gains tax is that if the gain is realized, i.e. the profit is used to buy another asset there is no tax. This is the roll over effect and is the usual for companies and those individuals who sell a home and re-purchase another; however in the case of George he is liable for Capital Gains Tax in respect to the sale of land. The problem with working out the Capital Gains Tax for George is whether the sale of the house was prior to 1st April 2005, if it was after it would be in a different tax year and the retail value of the separated property would have to worked out for 1985; however if the sale was before the 1st April 2005 then the method of calculation is simplified. Capital Gains Tax does not only apply only to property sales, but also the sale of any asset. Therefore the table and chairs which he purchased for 4000 pounds brought back a sizeable profit in 2004, i.e. it was sold for 14, 500 in total which is 10, 500 profit. Therefore inflation would be allowed to be deducted and the remaining figure is the amount that the Capital Gains Tax will be calculated from and George is liable to pay.
Bibliography:
Tax Law:
Carmichael, Corporation Tax, HFL
James & Nobes, 2004, The Economics of Taxation (7th Edition), Prentice Hall
Nobes & Parker, 1995, Comparative International Accounting, Prentice Hall
Soos, 1995, Taxation at Source and Withholding in England 1512 to 1640, British Tax Review pp 49-91
Company Law:
N. Bridge, 2004, Directors Behaving Badly, NLJ 154(7129)
Charlesworth and Morse, 1999, Company Law, Sweet & Maxwell
Department of Trade and Industry can be found at:
