This purpose of this paper, issued in September 1999, was to stimulate discussion of the corporation tax system as a whole with a view to simplifying it and bringing corporation tax profits more closely into line with accounting profits. Comments on our proposals were invited from members and from other organisations by 30 November 1999. In a later paper, we summarise the comments received and set out our further thoughts on how progress can be made with the reform of corporation tax. DOWNLOAD FULL PAPER
REFORM OF CORPORATION TAX
Corporation tax was introduced in 1965. It was not designed as a new tax, but was grafted on to the income tax legislation, which dates back to the Income Tax Act 1842, and the capital gains tax legislation, which was also introduced in 1965. In particular, it adopted the schedular system of income tax which was introduced to deal with the income of individuals, but which, in our view, is inappropriate for companies. A vast number of detailed changes to the legislation have been made over the years and the result is that, in many cases, the profits on which a company has to pay corporation tax may bear little relationship to its commercial profits, as shown by its accounts drawn up in accordance with the Companies Acts and Generally Accepted Accounting Practice (GAAP).
The need for a fundamental review
We believe that the time has come for a fundamental review of the corporation tax regime as a whole. In principle, companies ought to pay corporation tax on their commercial profits. Any departure from this principle ought to be the subject of a specific policy decision. We are aware that several aspects of the taxation of companies are presently under review but, in our view, any further amendment of the law should take place as part of a fundamental review and should be aimed at bringing taxable profits more closely into line with accounting profits.
We recognise that in any move towards the taxation of commercial profits, the distinction between capital and revenue is likely to become blurred and may cease to be relevant. This would not prevent policy decisions being made whereby the payment of tax on commercial profits from the disposal of certain assets could be postponed.
This paper is concerned with the single company. It may be that, if the reforms suggested in this paper are carried out, they could be followed by a reform of the taxation of groups at a later stage.
Focus on accounting standards
Any change to a system of taxing commercial profits would be based on the requirement to draw up accounts in accordance with UK GAAP. This would undoubtedly focus more attention on accounting standards than there is at present but, given that accounting standards are aimed at ensuring that accounts show a true and fair view, we think that they should be followed for tax purposes, subject to the kind of policy decisions referred to above.
The step by step approach to reform
It is acknowledged that recent legislation relating to forex and financial instruments, loan relationships and the taxation of rental income has eliminated many of the timing differences which used to exist as between accounting profits and taxable profits. The recent announcement by the Revenue regarding provisions in accounts takes us a step further in the direction of aligning taxable profits with accounting profits. It is hoped that the proposed codification of the law relating to the taxation of intellectual property will be based on accounts treatment and will, therefore, take another step towards alignment.
Perhaps the biggest single step towards aligning taxable profits with accounting profits would be the replacement of capital allowances with a deduction for commercial depreciation. The adoption of this proposal would not prevent the government from giving investment allowances for any particular category of expenditure which it wished to encourage in the future. More importantly, depreciation on all commercial buildings would be allowed, whereas at present only industrial buildings and scientific laboratories qualify. The present system does not reflect the growing importance of high tech businesses and information technology, but is rooted in the past, with its emphasis on heavy industry.
A further major step towards alignment would be to eliminate the various different rules for relieving different kinds of commercial loss. These rules are a consequence of the schedular system of corporation tax. The result of the rules is that some commercial losses may go unrelieved as far as tax is concerned. It is for consideration whether all commercial losses of a revenue nature should be dealt with in the same way and whether all of a company’s commercial activities should be regarded as a single taxable activity.
The step by step approach to reform is better than nothing, but we believe that a framework is required for future changes in the law. This can only be constructed on the back of the kind of fundamental review which this paper calls for.
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