Computing Taxable Income

Computing taxable income

Financial accounting, which is governed by a 'true and fair' presentation of financial position and the results of operations, does not share in all respects the principles which govern the computation of taxable income. Differences between 'book' and tax accounting originate from the following:

(i) Some items which appear in the income statement are not allowed for tax purposes. These include entertaining expenses of home-country customers and certain types of donations and subscriptions.

(ii) Dividends received from other companies which are resident in the UK, which is known as franked investment income, does not incur corporation tax, because the company making this payment will already have paid ACT on this dividend.

(iii) Timing differences. The first two categories give rise to permanent differences where, because of special legislation, particular revenues or expenses are omitted from the computation of taxable income. A timing difference, on the other hand, arises when an item is includable or deductible in income for tax purposes in one period, but in income for general reporting purposes in another. The different treatment of fixed assets creates timing differences because depreciation is not an allowable deduction for tax purposes, capital allowances being granted instead.

Deferred taxation

The provision for deferred taxation originates from the timing differences which we discussed above. SSAP 15, Accounting for Deferred Taxation, is intended to bring a greater degree of uniformity to the accounting treatment of taxation where there are differences of timing between accounting and taxation recognition of income or expenditure. According to this statement

'The effect of timing differences on taxation liability in relation to reported income

would be of little significance if taxation was not regarded as relevant to the performance of the business for the period, and the only accepted indication was the income before taxation. The view is widely held, however, that the income after taxation is an important indication of performance being the fund of earnings which supports (or perhaps does not support) the distribution of income by way of dividend. So far as the Balance Sheet is concerned, the relationship between funds provided by shareholders and other sources of finance may be distorted if provision is made for deferred taxation which can be demonstrated with reasonable probability not to be needed'.


Interested in The Development of a Conceptual Framework

Read on: Taxation in Company Accounts

Taxation in company accounts

Before April 2003, company income was liable for corporation tax and any distribution made from company income to shareholders liable to income tax in the hands of shareholders. Clearly, this system attempted to encourage companies to retain their earnings and increase investment.

The imputation system

A new system of corporation tax was introduced known as the imputation system. It had two basic objectives: (i) to eliminate the built-in discrimination which applied under the previous scheme against the distribution of income; (ii) to harmonize... see: Taxation in Company Accounts