Corporate and Personal Income Taxation | My Assignment Tutor

Working Paper (06.11.2020) Page 1 of 12Case Study:Corporate and Personal Income Taxation(Dreamland)I. Facts and CircumstancesOverviewCompany X is a stock corporation (1,000,000 shares) founded and taxed under the law ofDreamland (residence). It has two Shareholders A and B, as of 1 January 2019 owning 60%and 5% of the company respectively. Company X holds a 10% interest in Company Y and80% interest in Company Z, two other corporations located in Dreamland. Furthermore,Shareholder B is an unlimited liable partner of entity P, holding 30% of its interests.Shareholder A Company XOther shareholders35 % Company YShareholder B60 % 5 %10%Company ZPartnership POther partners80%30 % 70 %Working Paper (06.11.2020) Page 2 of 12Financial AccountingCompany X has prepared financial statements under national GAAP for the commercial yearending 31 December 2019. The accounting profit before taxes amounts to € 2,000,000. TheEBITDA is € 5,100,000. The set of financial statements looks as follows:Balance sheet as of 31 December 2019:2019 2018 2019 2018 Total Assets k€ k€Total Equity + Liabilities k€ k€Fixed assetsIntangibles 320 480Buildings 1.140 1.170Equipment 4.590 4.500Current assetsInventories 600 400Trade receivables 900 1.100Cash 2.700 2.000EquityCapital 5.000 5.000Retained Earnings 1.950 1.500Profit 1.710 580Long-term liabilitiesLoan 1.000 1.000Provisions 200 0Short-term liabilitiesTrade payables 390 1.57010.250 9.65010.250 9.650 Income statement for the Year 2019:2019 2018k€ k€Revenues 21.700 20.500Material expense -7.200 -8.900Personel expense -2.000 -2.000Other expenses -7.400 -7.000Depreciation -1.100 -1.200Operating profit 4.000 1.400Financial result -2.000 -500Income taxes -290 -320Profit 1.710 580Working Paper (06.11.2020) Page 3 of 12Inter alia, the following business transactions have been (for financial accounting purposescorrectly) reflected in these financial statements:• Intangible assets must be capitalized, whether they were self-created by the owner oracquired from third parties. In 2017, Company X capitalised a self-developed intangibleasset (patent from a new product) in the amount of € 800,000. It is amortised over itsuseful life of 5 years on a straight-line basis.• Company X stipulates a full cost approach for the measurement of inventories. All attributable production costs including all direct material costs and production costs aswell as production-related administration costs are included. The inclusion of an appropriate part of the indirect costs is also required. However, general administration costs(GA) are excluded. Total recognised inventory amounted to € 400,000 (excluding GA of€ 100,000) and € 600,000 (excluding GA of € 150,000) as of 1 January and 31 December 2019 respectively.• In 2008, Company X has acquired an office building for a net purchase price (incl. directlyattributable auxiliary costs of purchase as well as subsequent acquisition costs) of€ 1,500,000. It is amortised over its economic life of 50 years on a straight-line basis.• Company X has signed a forward contract to buy steel in the course of 2020 for a predetermined fixed price per unit. Unfortunately, the marked price of steel has declined below the contractual price in the course of 2019 and the contract has become onerous.Therefore, a provision for the expected loss of € 200,000 is recognised as of 31 December 2019.The accounting profit (income statement) also includes the following income and expensesincurred in the course of 2019:• Charitable contributions in the amount of € 60,000;• Fines in the amount of € 100,000;• Gains from the sale of business assets in the amount of € 45,000;• Fees paid to the supervisory board members in the amount of € 250,000;• Salaries paid to management board members in the amount of € 800,000;• Salary of Shareholder A who is an employed advisor to the Company in the gross amountof € 50,000 (net amount after withholding wage tax is € 37,000). The fair (arm’s length)salary for his involvement would have been € 30,000.Working Paper (06.11.2020) Page 4 of 12Transactions with ShareholdersCompany X got a bullet loan from Shareholder A in 2014, nominal amount € 1,000,000, effective interest rate 9% p.a. The loan will be paid back in 2022. The fair market rate for thisloan would have been 5% p.a.Company X pays a yearly rent of € 30,000 for office premises belonging to the Shareholder B.The rent to be expected from a third party providing a similar service would have been€ 40,000 p.a.Financing ActivitiesIn the course of 2019, Company X received dividends (accounted for as finance income under local GAAP)• from Company Y in the amount of € 1,000,000;• from Company Z in the amount of € 1,000,000;Company Y’s taxable income for the year 2019 is € 1,100,000 for CIT and € 900,000 for TITpurposes. Company Z’s taxable income for the year 2019 is € 1,100,000 for CIT and€ 900,000 for TIT purposes.All other remaining financing transactions of Company X result in net finance expenses of€ 4,000,000, comprising € 7,500,000 interest expense and € 3,500,000 interest income forthe year 2019.Shareholder’s Investments and FinancingIn early 2019, Company X paid dividends in the amount of € 120.000 to Shareholder A and€ 10.000 to Shareholder B related to prior years’ profits.Due to the bad performance of Company X in prior years,• Shareholder A sold 10 % of the Company’s shares to other shareholders in mid 2019 for€ 10 per share;• Shareholder B sold 3 % of the Company’s shares to other shareholders in late 2019 for€ 11 per share;leading to a revised structure of ownership for Company X with 50 % interest of ShareholderA and 2 % interest of Shareholder B.Shareholder A bought all his shares in 2009 for € 7 per share. Shareholder B bought all hisshares in 2011 for € 9 per share.Working Paper (06.11.2020) Page 5 of 12Other Tax-relevant MattersCompany X has unused corporate tax losses of prior periods in the total amount of€ 2,500,000 and unused trade tax losses of € 800,000. (No other corporation, partnership orindividual involved has a tax loss carry-forward.)Corporate taxes in Dreamland are assessed on an annual basis, but advance payment is required in quarterly instalments. In the course of 2019, Company X (as parent of the fiscalunit with Company Z) prepaid CIT in the amount of € 37,500 each quarter and TIT in theamount of € 35,000 each quarter.As Company X controls Company Z the two have opted to form a fiscal unity for both CIT andTIT purposes.PartnershipProfits and losses of entity P are allocated to the individual partners directly in form of aprofit distribution, as laid down in the partnership agreement (i.e. proportionate share ofthe partners’ interests). In 2019, entity P had a taxable business profit of € 450,000.Working Paper (06.11.2020) Page 6 of 12II. Dreamland’s applicable Tax LawOverviewThe corporate tax system in Dreamland follows the corporate principle. Business profit isbased on the financial statements under the accrual principle (calendar year is also the fiscalyear). Company X is eligible for group taxation (as a parent).Dreamland applies the following corporate tax rates:• State CIT rate: 15% flat; and• Local TIT rate: 3,5% multiplied by a municipal factor of 400%.Dreamland has implemented a double taxation relief system on the shareholder level:• Therefore, Dreamland applies a flat PIT tax rate of 25% to capital gains and capital income (with final withholding at source of taxes to capital gains and income from shareholdings as well as interests from loans).• However, for substantial shareholders with a participation of 10 % or more, capital gainsare qualified as business income and are subject to progressive taxation (see below).Business income, rental income and all other taxable personal income is subject to the following progressive tax rates (withholding and/or final assessment):• A 20% rate applies to income from € 1 to € 20,000;• a 30% rate applies to income from € 20,001 to € 100,000; and• a 40% rate applies to all income above € 100,000.Tax AccountingThe following tax accounting principles apply for business profits in Dreamland:Recognition of intangiblesThe capitalisation of self-developed intangible assets is prohibited, mostly because of doubtsas to the actual value.Production costs of inventoryGeneral administration costs have to included in the production costs of inventory.Working Paper (06.11.2020) Page 7 of 12Depreciation of propertyStraight line depreciation for assets is a deductible expense for tax purposes. The annualdepreciation is calculated by dividing the purchase price by the estimated useful life of theasset. However, for office buildings the annual amortisation rate is set by Dreamland’s national tax authorities to 3%.Provisions from onerous contractsDreamland‘s tax law generally define a provision as a liability of uncertain timing andamount. Provisions should only be recognized when a present obligation arises out of a pastevent, an outflow of resources is probable, and the amount of the obligation can be estimated reliably. However, the recognition of provisions for expected losses from onerous contracts is prohibited.Contractual Relations with ShareholdersWhen Dreamland’s the tax authorities discover a hidden distribution they increase the corporate profit accordingly and the corporation has to pay the additional corporate incometax. On the shareholder level, the income is requalified as a dividend and the tax paid on theincome will be offset against that now due on the dividend.In the case of a hidden capital contribution, the corporation adjusts the consideration received to the arm’s length price, and thus reduces its income as originally declared.Deductions and ExemptionsTax-exempt incomeProfit distribution receipts such as dividends are excluded when determining the corporateincome (participation privilege). 5% of these receipts is deemed to constitute expense thatmay not be deducted as a business expense.Non-deductible expenses20% of charitable contributions are treated as business expense for corporate income taxpurposes. Fees paid to the supervisory board members are only eligible for deduction at theamount of 50%. The deduction of fines is excluded.Deductibility of interest paymentsGenerally, interest payments are fully deductible as operating business expenditure. However, some special rules apply for corporate groups domiciled in Dreamland. If the amount ofinterest payments exceeds the amount of interest earnings for more than € 3 million, theseWorking Paper (06.11.2020) Page 8 of 12exceeding interest payments are only deductible up to an amount of 60% of the EBITDA (acc.to financial accounting).Group TaxationDreamland has implemented a fiscal unity concept and taxes a group of companies as if theywere just one entity if they are controlled by the same parent. Profits and losses are mutually offset and inter-company gains and losses are eliminated (true consolidation). Taxation ofinter-company transactions is thus deferred.Loss Carry-Back and Loss Carry-ForwardLimitationsLosses for corporate and trade income tax purposes can be carried back for one year, limitedto a total loss amount of € 1 million.Losses can be carried forward with no time restriction. Up to an amount of € 1 million losscarry-forward is possible – free from any restrictions. For sums in excess of € 1 million, atleast 40% of the taxable income must remain subject to taxation. In other words, a maximum 60% of taxable earnings exceeding € 1 million can be offset against incurred losses.Trade Income TaxTIT is not deductible from the CIT taxable income or vice versa and Dreamland’s tax principles to determine the taxable income for CIT and TIT purposes are basically the same. However, the following principles differ for TIT purposes:A quarter of the sum of following deemed expenses shall be added back to the profit fromcommercial business to the extent that they were deducted in determining business profit:• Half of the lease expenses for immovable property; and• Salaries paid to management board members.Dividends from shares in a corporation are added back to the extent they fail the holdingrequirement of at least 15 % of the shares (i.e. no participation privilege).Personal Income TaxOnly realised capital gains are subject to PIT (accrual concept II). Capital gains from substantial shareholdings which are qualified as business income are partially exempted from PIT:Only 60 % of these gains are taxed (shareholder relief).Working Paper (06.11.2020) Page 9 of 12Taxation of PartnershipsPartnerships in Dreamland are not taxed with CIT on business profits when earned. Rather,each partner is subject to PIT on his share of the profits based on the partnership agreement(transparency principle). The profit allocations qualify as business income at the level of thepartner.Business profits from partnerships in Dreamland are subject to TIT. Dreamland has introduced an imputation system to compensate the additional trade tax charge in PIT. The imputation credit is based on a fixed municipal factor of 400%.Working Paper (06.11.2020) Page 10 of 12III. RequirementsPlease prepare the income tax assessments for Company X and the Shareholders A and Bwith the help of the two attached calculation schedules for CIT/TIT and PIT in Dreamland.• Please calculate the additional payment/refund of corporate income tax (CIT) of Company X for the fiscal year 2019.• Please calculate the additional payment/refund of trade income tax (TIT) of Company Xfor the fiscal year 2019.• Please calculate the additional payment/refund of personal income tax (PIT) of theShareholders A and B for the fiscal year 2019.• What are Company X’s effective CIT and TIT rates based on the accounting profit?Calculations shall be comprehensible and traceable!Assumptions:• Shareholders A and B have no other sources of taxable income than the ones describedin the above fact pattern.• Please assume that Dreamland’s tax authority will identify and consider all contractualrelations at arm’s length.• Dreamland has no social security systems in place.• There exist no tax allowances other than the ones described in the fact pattern.• Please do not consider effects of any other taxes than CIT, TIT and PIT.• There exist no other contractual relations between the Shareholders A and B and/or theCompanys X, Y and Z and entity P than the ones described in the fact pattern.Working Paper (06.11.2020) Page 11 of 12CIT and TIT Calculation ScheduleCalculation Ref.: Corporate Taxation of Company Xofit or loss from financial accountingTax accounting adjustmentsRecognition principlesMeasurement principlesCITTITTotalxable business profitContractual arrangementsHidden profit distributionHidden capital contributionTotalNon-deductible expenses & tax-exempt incomeNon-deductible expensesTax-exempt incomeFat and thin capitalisation rulesTotalFiscal unityTaxable income from other group comanpiesElimination of intercompany transactionsTotalLoss carry-back and loss carry-forwardUnused lossesLimitations and loss trafficking provisionsTotalpayment (-) / refund (+) on CIT & TIT 1 2 3 = (1+2) 4 5 = (3+4) Taxable profit6 7 = (5+6) Income8 9 = (7+8) Group income10 11 = (9+10) Taxable income12 Tax rate13 = (11×12) Assessed tax14 Advance payments15 = (14-13) FinalWorking Paper (06.11.2020) Page 12 of 12PIT Calculation ScheduleCalculation Ref.: Personal Taxation of the ShareholdersEmployment incomeSalary (Management board of Company X)ABTotalRental incomeContractual rent (Office building)Hidden capital contributionTotalCapital incomeInterest incomeDividends receivedConstructive dividendsTotalCapital gainsSale of SharesTotalBusiness incomeSale of SharesTax-exempt gainsIncome from partnershipsTotalthereof shareholder relief (25%)thereof progressive taxation (up to 40%)rateat 25%at 20%at 30%at 40%Wage taxCapitalal payment / refund on PIT 1 2 3 4 5 6 = (3+4+5) 7 8 9 10 11 = (8+9+10) 12 = (1+2+6+7+11) Taxable income13 = (6+7) 14 = (1+2+11) Tax 15 = Sum of: Assessed tax25%*13 20%*14 up to 20k 30%*14 up to 100k 40%*14 above 16 = Sum of: Withhold at sourcefrom fact pattern 25%*(3+4+7+8) 17 = -(10*3,5%*400%) TIT imputation credit18 = (15-16-17)

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