The Chartered Tax Adviser Examination

November 2011

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Advanced Corporation Tax

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Advisory Paper

TIME ALLOWED – 3 HOURS

 You should answer all SIX questions.

 Start each answer on a new sheet of paper and write on one side only. Do not write in
the left-hand margin.

 All workings should be shown and made to the nearest month and pound unless
the question specifies otherwise.

 Marks are specifically allocated for presentation.

 Candidates who answer any law elements in this paper in accordance with Scots
law or Northern Ireland law should tick the appropriate box on the front of each
answer folder.

 Unless otherwise indicated by the provision of additional table information, you may
assume that 2010/11 rates and allowances continue to apply for 2011/12 and
future years. Candidates referring to actual or pending rates and allowances for
2011/12 and future years will not be penalised.
1. You are the in-house tax manager for a large conglomerate, Holdings plc. The group is
growing rapidly by pursuing a vigorous acquisition strategy. The finance director has
sent you information from the due diligence report on a UK based acquisition target.
The acquisition target consists of various UK group companies. The finance director
has told you that in order for the acquisition to be commercially justifiable it is important
that group relief is available for trading losses and non-trading loan relationship deficits
between all the UK companies in the target group and also, post acquisition, between
the acquired UK companies and the rest of the Holdings plc group.

From the due diligence information, you have established the following:

The group structure arose as a result of a management buyout a number of years ago.
Albinoni Ltd (A), Bach Ltd (B) and Chopin Ltd (C) only have one class of share capital,
Ordinary Shares, but Dvorak Ltd (D) has two classes of share capital: Ordinary shares
and Preference shares. The Ordinary Share capital of each company is owned as
follows:

A Ltd

75%

B Ltd

100% 100%
Preference
C Ltd D Ltd shares

Albinoni Ltd has bank debt that was used to fund the acquisition of the 75% interest in
Bach Ltd. Albinoni Ltd has non-trading loan relationship deficits arising on an annual
basis.

Bach Ltd is a profitable trading company. It has issued Ordinary Share Capital of
100,000 £1 ordinary shares. 75,000 are owned by Albinoni Ltd and 25,000 owned by
the management team. In addition the Boards of Albinoni Ltd and Bach Ltd have jointly
resolved to grant unapproved options over a further 10,000 shares in Bach Ltd to
selected key employees of Bach Ltd although this has not at this stage been
implemented. Bach Ltd also has a term loan of £500,000 from a bank, the interest rate
on which depends on the results of the business of Bach Ltd. The rate of interest is
stated to be 5% per annum if the net asset value of Bach Ltd at the end of the previous
accounting period is greater than £2 million and increases by 1% for each £500,000
that the net asset value at the end of the previous accounting period is less than
£2 million, with a maximum rate of 9% per annum. There is no premium payable on the
repayment of the loan.

Chopin Ltd has a term loan of £100,000 from a bank which is convertible into Ordinary
shares in Chopin Ltd. The term loan carries interest at a rate of 5% per annum and the
conversion terms depend on the performance of Chopin Ltd. The greater the amount of
the net assets of Chopin Ltd at the end of the term of the loan, the less the number of
shares receivable on conversion of the loan.

Continued

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1. Continuation

Dvorak Ltd has issued ordinary share capital of 500,000 £1 ordinary shares all of which
are owned by Bach Ltd. In addition, it has 200,000 £1 non-cumulative preference
shares (owned by a venture capital company) entitling the holders thereof to a fixed
non-cumulative dividend at the rate of 10% in priority to the payment of dividends on
the Ordinary Shares.

You are required to draft notes for the finance director explaining the availability
of group relief both before acquisition (i.e. within the target group itself) and
within your group after acquisition of the target. You should also set out any
additional information which may be required to conclude on whether group
relief is available for the trading losses and non-trading loan relationship losses
incurred to date.
(20)

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2. You are a tax manager at a firm of accountants. Your client, the Green group, consists
of a holding company, Green Ltd, plus two wholly-owned subsidiary companies, Brown
Ltd and Red Ltd. The only activity within Green Ltd is the receipt of dividends from
group companies and the payment of dividends to shareholders. Brown Ltd has been a
trading company in the past, and Red Ltd is an investment company which until
recently owned a property occupied by Brown Ltd for trade purposes. All companies
are UK incorporated and resident and have a 31 December year-end.

Until 31 December 2009, Brown Ltd was profitable. However on 4 January 2010 it lost
its main customer which meant that it became loss making. On 31 March 2011 it went
into administration and on 31 August 2011 it went into liquidation. The liquidator
continued to trade until 30 September 2011 when the trade, excluding the liabilities,
was sold at net book value (goodwill nil) to a newly-formed subsidiary of Green Ltd,
Yellow Ltd. At that date the property owned by Red Ltd was also transferred to Yellow
Ltd at full market value. Yellow Ltd was then sold to an independent purchaser on
31 October 2011.

On 1 November 2011 the liquidator received a compensation payment of £100,000 in

settlement of an old trade dispute with a supplier.

The liquidator will make an interim distribution in the course of winding up on 1

December 2011 and a final distribution on 30 September 2012, on which date the
winding up will be completed.

The Corporation Tax profits and (losses) of Brown Ltd, which all arise from its trade,
are as follows:

Year ended 31 December 2007 – profit £500,000

Year ended 31 December 2008 – profit £960,000
Year ended 31 December 2009 – profit £900,000
Year ended 31 December 2010 – loss (£330,000)
Period to 30 September 2011 – loss (£1,800,000)

The loss for the period to 30 September 2011 accrued evenly over the period.

Red Ltd has made a Corporation Tax profit of £90,000 every year up to and including
the year ended 31 December 2010, and will make Corporation Tax profits of £60,000 in
its accounting period ended 31 December 2011.

You are required to prepare notes for the tax partner explaining the Corporation
Tax consequences of the above events and transactions for the Green group.
(15)

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3. You have recently been appointed as the in-house tax director at ConsolPharma, a
large group listed on the London Stock Exchange. It comprises the parent company,
Consolidated Pharmaceuticals plc, and a number of wholly owned UK and overseas
trading companies. The group finance director has asked you to review the tax history
of the parent company and all subsidiary companies for the past six years up to and
including the year ended 31 March 2010. All submitted UK tax computations have been
filed a few days before the statutory time limits. All companies have 31 March year-
ends.

Your review brings to light the following:

1) The UK tax computations for Drug Deliveries (UK) Ltd for the years ended
31 March 2007 and 31 March 2008 contain errors whereby foreign exchange
losses of £150,000 and £200,000 respectively have incorrectly been treated as
not allowable. The computation for the earlier period has not been subject to
enquiry, while the later computation remains under enquiry for an unrelated
matter.
2) Drug Manufacturing (UK) Ltd has undertaken qualifying Research and
Development (R&D) since the year ended 31 March 2009 but has overlooked
claiming R&D reliefs amounting to £100,000 in each of its UK tax computations
for the accounting periods to 31 March 2009 and 31 March 2010. There are no
open enquiries on either computation.
3) Asian Pharma (Hong Kong) Ltd is registered in Hong Kong and began trading on
1 April 2009. It is not a controlled foreign company. It has not received any
notices to make UK tax returns and has not done so. A report recently
commissioned from the group's external tax advisers indicates that the
company’s central management and control has been situated in the UK since 1
April 2009. It has made substantial trading profits throughout and suffered Hong
Kong tax on its profits at rates averaging 10%.
4) The UK computations for Drug Retailing (UK) Ltd contain the following errors:

(a) Year ended 31 March 2006 – depreciation has been deducted rather than
added back. No enquiry has been made into the computation by
HM Revenue & Customs.
(b) Year ended 31 March 2008 – after a long enquiry it has been agreed with
HM Revenue & Customs that a compensation receipt of £1 million, treated
in the computation as non-taxable, is in fact taxable. It has also been
agreed that one half of the receipt is taxable in the year ended 31 March
2007 and one half in the year ended 31 March 2008.
(c) Year ended 31 March 2009 – disallowable entertaining of a foreign
supplier, amounting to £20,000, has not been added back. The working
papers clearly indicate that the expense was identified when the
computation was prepared and that the predecessor in-house tax director
decided not to disclose it in the computation.

5) Consolidated Pharma (Head Office Services) Ltd entered into a tax scheme in
the year ended 31 March 2009 which was disclosable under the Disclosure of
Tax Avoidance Schemes rules. The scheme sponsor (an outside accountancy
firm) provided the company with the scheme reference number but the company
omitted to include the number on its return.

You are required to write a report for the group finance director setting out the
consequences of each of the above, and to make recommendations on how they
should be resolved.

You are not required to prepare calculations or computations. (15)

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4. You are the tax manager at a firm of accountants. You have recently met the finance
director of a new tax client, EuroAmerican Holdings Ltd, a UK registered and resident
company. It is wholly owned by its US resident parent company EuroAmerican Inc.
EuroAmerican Holdings Ltd acts as a holding and financing company for a number of
UK and other European manufacturing companies.

The finance director has provided you with the following information:

1) For a number of years EuroAmerican Inc. has made loans to EuroAmerican

Holdings Ltd. The loans outstanding at any time have totalled up to US $ 100
million. EuroAmerican Holdings Ltd in turn has made loans to its wholly-owned
trading subsidiaries. Interest has been paid on all these loans at rates which
have enabled EuroAmerican Holdings Ltd to make a profit on its borrowing and
lending activities.

2) In order to generate further working capital for the group, EuroAmerican Holdings
Ltd now proposes to borrow a further £50 million from an independent Swiss
bank, with the loan being guaranteed by EuroAmerican Inc. These additional
funds will be used to provide further loans to EuroAmerican Holdings Ltd’s
trading company subsidiaries.

3) A UK resident company (Eurocash Ltd), will dispose of all its assets for cash and
pay off its liabilities. It will then lend the net cash balance interest-free to
EuroAmerican Holdings Ltd and become dormant.

4) The US parent company has identified a developing market in Poland for a

particular line of the group’s products which are manufactured in the UK. To
exploit this market it has decided to create a new subsidiary company of
EuroAmerican Holdings Ltd in Poland to act as an importer and distributor, in
Poland, of the group’s UK manufactured products. To enable the Polish
company to win market share in Poland, goods for sale will be priced
competitively and below prevailing market prices. The Polish company will
require financial support from the UK to enable it to do this and remain solvent.
The form that support will take has not been decided, pending an understanding
of the transfer pricing considerations.

You are required to write a report for the finance director setting out:

1) The basis of UK transfer pricing by reference to the relevant UK legislation

and the Organisation for Economic Co-operation and Development (OECD)
Model Tax Convention and Transfer Pricing Guidelines; and

2) The UK transfer pricing implications of the matters referred to above.

You are not required to prepare calculations or computations or to address

worldwide interest capping rules or foreign exchange issues.
(20)

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5. You are the group tax manager of a large quoted company, Health plc, which operates
in the health care industry. The company manufactures and supplies pharmaceuticals
and other health care products and has a large research facility.

Health plc is considering the acquisition of Research Ltd and you have undertaken a
review of its tax affairs. Research Ltd undertakes Research and Development and your
finance director has asked to you calculate the enhanced research and development
tax relief that would be available in Research Ltd as the likely Corporation Tax liability
of Research Ltd post acquisition will be a factor influencing the decision on the
consideration to offer for the company.

Research Ltd is currently an SME carrying out research into new drugs for the
treatment of cancer. HM Revenue & Customs have accepted that the various research
projects qualify as Research & Development for the purposes of the enhanced reliefs in
CTA 2009, Part 13.

In its accounting period ending 31 March 2012, Research Ltd is expecting to incur the
following costs in relation to its qualifying research projects:

Project A – research sub-contracted out to Research Ltd by another unconnected large

company
£’000
Staffing costs in relation to employees of Research Ltd directly and actively
engaged in the research 150
Payments to Cambridge University in respect of research sub-contracted
out to them 75
Payments made in respect of a team of computer programmers, who are
engaged through an agency, to develop software to model the results of
the university research 100
Payments made to a self-employed retired professor to advise Research
Ltd on its research and to direct the work of the computer programmers 50
Project B – research undertaken by Research Ltd itself

Staffing costs in relation to employees of Research Ltd directly and

actively engaged in the research 200
Software costs for software that is employed directly in the research 25
Payments to an independent SME for work sub-contracted out to them 125
Contribution to independent research on cancer drugs being undertaken
by a partnership in which the controlling shareholder of Research Ltd is a
partner. Payments of £20,000 made quarterly in arrears on 30 June, 30
September, 31 December and 31 March each year 80

You are required to:

1) Calculate the Corporation Tax relief available on this expenditure for the
accounting period ended 31 March 2012 on the assumption that Research
Ltd is acquired by Health plc on 31 December 2011; and (6)

2) Indicate what further information Health plc’s solicitors should seek from
the sellers through their due diligence questionnaire to enable you to
confirm that the various conditions for the enhanced Research and
Development relief will be met in relation to this expenditure; and (5)

3) State any ways in which the arrangements in respect of these two projects
might be changed post acquisition to increase the amount of Corporation
Tax relief available. (4)

Total (15)

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6. You are a manager in a firm of tax advisers and have received an email from Mr
Matthews, the new finance director of a client company, Metropole Ltd, which is the
parent company of a large UK based group of publishing companies which reads as
follows:

“As you will be aware, one of Metropole Ltd’s wholly owned subsidiaries companies,
Star Ltd, is a UK based publishing company. Star Ltd’s business has been badly
affected by the global recession and it has been trading at a loss for the last three
years. The losses have, in the main, been funded by a bank loan secured by a fixed
and floating charge over the assets of Star Ltd. On 30 June 2011, the end of the most
recent accounting period, the amount of the loan from the bank to Star Ltd had reached
£10 million and the bank had indicated that no further advances under the loan facility
would be made. On 30 June 2011, the net assets of Star Ltd were estimated to be
approximately £1 million.

As a separate matter, we sold Epsilon Ltd, another UK based publishing company, to

one of our competitors 24 months ago. Epsilon Ltd was a wholly owned subsidiary of
Metropole Ltd until it was sold. We understand that Epsilon Ltd has also been affected
by the recession and has been trading at a loss since it was acquired by the
competitor. We understand that Epsilon Ltd’s recent losses have also been funded by
bank borrowings and at 30 June 2011 the bank borrowings stood at approximately £15
million. When Epsilon Ltd was previously a wholly owned subsidiary of Metropole Ltd,
Metropole Ltd had loaned Epsilon Ltd £5 million as an unsecured loan and this loan is
still outstanding. We are making an impairment provision in Metropole Ltd against the
whole of the loan to Epsilon Ltd in the accounting period ended 30 June 2011. We
understand that the net assets of Epsilon Ltd as at 30 June 2011 are likely to be
insignificant.

At the Board meeting of Metropole Ltd yesterday the Board decided that there would be
commercial benefits by bringing Epsilon Ltd back into the Metropole Ltd group and
refinancing both Star Ltd and Epsilon Ltd from within the group. Accordingly, subject to
resolving any Corporation Tax issues, the Board are considering the following:

1) Offering to acquire from the bank for a consideration of £1 million the debt of £10
million owed by Star Ltd to the bank.

2) Offering to re-acquire from the competitor for a consideration of £1, the entire
issued share capital of Epsilon Ltd.

3) Offering to acquire from Epsilon Ltd’s bank, for a consideration of £2 million, the
debt of £15 million owed by Epsilon Ltd to the bank.

4) Formally waiving the loan of £5 million due from Epsilon Ltd to Metropole Ltd.

Can you please let me know the Corporation Tax consequences if the Board were to
resolve to take these steps”.

You are required to prepare detailed notes for your tax partner setting out the
advice that you would give Mr Matthews together with detailed reasoning for that
advice. You should deal only with the Corporation Tax issues arising under the
Loan Relationship legislation in Parts 5 and 6 of CTA 2009, not the wider
Corporation Tax issues arising from the reacquisition of the shares in Epsilon
Ltd. (15)

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