Limited Company question

[audi321]

Hi all, could someone sort an argument out between me and someone at work.

If for example, a company which only holds one residential investment property (let's say it's worth £100k) has income of £10k and loan interest and annual costs of £6k, therefore has taxable income of say £4k.

If the property increases in value to £120k in the next annual accounts (and all other figures remain the same) is the profit affected, or is the corporation tax still based on £4k profit?

Thanks for any help and hopefully winning me the argument (I say it's unaffected until the property is sold).

[BoRED S2upid]

I’m with you. You win until an accountant pops along and proves us wrong.

[bristolbaron]

I’m with S2upid!

[UrbanAchiever]

Just because the value of the property goes up in the open market doesn't mean you have to reflect that in the accounts. It can stay at the same level in the accounts it was previously.

If you choose to revalue it in the accounts, your fixed assets increase by that amount. The balancing entry is an increase in (or creation of) a revaluation reserve which sits with the profit and loss account in the capital and reserves section of the balance sheet..

It has no impact on the profits of the business and therefore no additional corporation tax is payable.

When the property is sold there will be a profit on disposal which would then incur a tax charge.

Edited by UrbanAchiever on Wednesday 28th September 22:10

[964Cup]

The company will carry a corporation tax charge equivalent to (at present rates) 19% of the gain which will be payable when the property (or the company) is sold. In this way the company's net assets correctly reflect its value.

[audi321]

Thanks guys......so it can increase on the balance sheet without impact to the P&L until it is sold.......I win

[MaxFromage]

audi321 said:

Thanks guys......so it can increase on the balance sheet without impact to the P&L until it is sold.......I win

Incorrect I'm afraid. As 964Cup alludes to, a provision is made for the tax due. This is called deferred tax and is shown under tax on the 'P&L'. The opposite entry is a provision on the balance sheet. However if your argument was over corporation tax on the P&L, then you are correct...

[audi321]

MaxFromage said:

audi321 said:

Thanks guys......so it can increase on the balance sheet without impact to the P&L until it is sold.......I win

Incorrect I'm afraid. As 964Cup alludes to, a provision is made for the tax due. This is called deferred tax and is shown under tax on the 'P&L'. The opposite entry is a provision on the balance sheet.

I'm confused. 964Cup said ' the 19% is payable when the property is sold' In this scenario, the property is not being sold, it's a paper increase. Are you saying that if it increases on paper by £20k, then 19% corporation tax is payable in that year on the £20k? What does deferred mean? Not payable in that year? I assume most companies don't show increases then and keep the value as the acquisition value?

Edited by audi321 on Wednesday 28th September 22:57

[AndyAudi]

Is this the explanation you seek
https://en.m.wikipedia.org/wiki/Historical_cost

[Eric Mc]

Deferred tax is a provision for the FUTURE Corporation Tax that MIGHT be payable when the revalued asset is eventually disposed of or sold.

For instance, take an asset (e.g. a building) which had an original cost of £100,000. It will initially be shown in the balance sheet at its original £100,000 cost. After 10 years, the directors decide that its true value is more like £300,000 and they would like to reflect that value in their company balance sheet (cos' it makes the company look good - ask Donald Trump).

They therefore increase the asset in the balance sheet to £300,000. Accountants do everything in twos so the other side of the transaction is that the reserves in the balance sheet of the company are increased by £200,000. Neither of these two adjustments have a direct impact on the company's profit and loss account.

However, it is obvious that the company has an appreciating asset and that, at some point, if the asset is eventually sold, there will be a Capital Gain on the sale and a resultant Corporation Tax liability arising. Rather than wait for that event (which may be years down the line), accounting regulations require that an estimate of the expected Corporation Tax is provided in the accounts and carried forward year on year until the genuine sale happens. This is what is known as "Deferred Tax" and the two sided entry is that the deferred charge is allocated to the Profit and Loss account as a charge and a liability for the deferred tax is shown in the balance sheet.
If the valuation of the property changes at any point in the future (either up or down), then the deferred tax provision needs to be amended. The provision also needs to be amended if the tax rules or rates change.
So, as you can see, a property revaluation will have an effect on the profit and loss account and on the reserves of the company. These changes can affect future policies of the company, such as decisions around dividend payments or applications for borrowing.

[audi321]

Thank you Eric Mc. The award for plain English’s goes to you.

Cheers.

[Eric Mc]

Accounting principles can be quite logical and obvious - but sometimes unfortunately, use of "accounting terminology" and "jargon" makes it difficult for non-accountants to understand these principles.