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 NOW IN ITS TWENTY-THIRD EDITION

TAXATION
TAXATION
‘An extremely well written and comprehensive book which is not only an excellent fit with the
current learning outcomes in taxation but is very user friendly and well received by students.’
Dr Justin Hof, University of Dundee
‘A highly comprehensive, well written book, full of helpful examples, and deservedly secure in its
place as the UK’s leading tax textbook.’
Christopher Coles, University of Stirling

FINANCE ACT 2017

Reviews of the previous edition

Now in its 23rd annual edition, Melville’s Taxation continues to be the definitive market-leading text on UK
taxation. Featuring clean, uncluttered prose and a wealth of immensely practical examples, this text is a
comprehensive guide for students taking a first-level course in the subject.
ALAN MELVILLE
This edition brings the book completely up to date with the provisions of the Finance Act 2017, including:

• Making Tax Digital (MTD) • The cash basis threshold

• Revised Budget timetable • Enabler penalties
• Income tax in Scotland • Reform of corporate loss relief
• Cash basis for property businesses • Corporate interest expense restriction
• Employee shareholder status • IHT main residence nil-rate band
• Taxation of termination payments • Deemed domicile

This book will be of value to both undergraduate and professional students of business and accounting, TWENTY-
and will be particularly useful for students preparing for the following examinations: THIRD
ICAEW Certificate Level, Principles of Taxation; ACCA Fundamentals Level, Taxation; ACCA Technician
EDITION
Scheme, Foundations in Taxation; CIPFA Diploma Stage, Taxation; AAT Professional Diploma, Personal
Tax and Business Tax; ATT Certificates, Personal Taxation; Business Taxation and Accounting Principles;
AIA Foundation Level, Auditing and Taxation; IFA Level 4, Tax for SMEs.

MELVILLE
FINANCE ACT 2017
ALAN MELVILLE FCA BSc Cert Ed. is a best-selling author. Previously a Senior Lecturer at Nottingham
Trent University, he has many years’ experience of teaching accounting and taxation.

Visit www.pearsoned.co.uk/melville for our suite of resources to accompany this textbook:

• For instructors: a complete solutions guide and PowerPoint slides for each chapter
• For students: a companion website featuring opportunities for extra practice, links to
relevant web pages and additional resources

Front cover image © Getty Images www.pearson-books.com

◆ OVER 250 WORKED EXAMPLES ◆ OVER 250 EXERCISES AND QUESTIONS ◆

CVR_MELVI_23_00804.indd 1 06/07/2017 11:25

 Contents

Basis of assessment 254 Part 3 Corporation Tax

Rates of CGT 255
Relief for capital losses 257 23 Introduction to corporation tax 341
Relief for trading losses 259 Scope of corporation tax 341
Administration of CGT 261 Accounting periods 342
18 Computation of gains and losses 265 Taxable total profits 343
Layout of a CGT computation 265 Trading income 344
Disposal value 266 Income from property 349
Allowable expenditure 266 Income from non-trading loan
Part disposals 268 relationships 349
Assets with negligible value 270 Dividends received 351
Assets held on 31 March 1982 271 Relief for charitable donations 351
Loan relationships 352
19 Chattels and wasting assets 275 Long periods of account 356
The chattels exemption 275 Research and development tax
Chattels disposed of at a loss 277 relief 358
Part disposals of chattels 277 Intangible fixed assets 359
Wasting chattels 280
Wasting assets 281 24 Corporate chargeable gains 363
Leases 283 Chargeable disposals and chargeable
assets 363
20 Shares and securities 292 Basis of assessment 364
The share matching rules 292 Computation of gains and losses 364
The Section 104 holding 294 Indexation allowance 365
Bonus issues 296 Assets held on 31 March 1982 368
Rights issues 298 The rebasing election 371
Capital distributions 300 Assets acquired before 6 April 1965 371
Takeovers 302 Disposals of shares or securities 372
Gilts and qualifying corporate bonds 304 Disincorporation relief 380
21 Principal private residence 308 25 Computation and payment of
Principal private residence 308 the corporation tax liability 385
Partial exemption 309 Corporation tax financial years 385
Deemed residence 310 Rates of corporation tax 386
Letting relief 312 Due date of payment 387
Business use 314 Accounting for income tax deducted
22 CGT reliefs 317 at source 390
Damaged assets 317 Shadow ACT 390
Destroyed assets 320 Self Assessment 391
Replacement of business assets 321 Interest on underpaid and overpaid
Gift of business assets 324 corporation tax 392
Transfer of a business to a limited Penalties 394
company 326 26 Corporation tax losses 398
Entrepreneurs' relief 327 Relief for trading losses (existing
Reinvestment into EIS shares 330 legislation) 398
Loans to traders 331 Carry forward of trade loss relief 399
Review questions (Set B) 334 Unrelieved charitable donations 400

vii
Contents

Trade loss relief against total profits 402 30 Value added tax (2) 471
Repayments of corporation tax 405 Accounting for VAT 471
Anti-avoidance legislation 407 The tax point 472
Choice of loss relief 407 Tax invoices 472
Proposed reforms to carry forward loss Accounting records 473
relief 408 Special schemes 474
Non-trading losses 409 Retail schemes 477
Bad debts 478
27 Close companies and investment
Non-deductible input tax 479
companies 412
Partial exemption 481
Close companies 412
Administration of VAT 483
Definition of a close company 412
Penalties, surcharges and interest 485
Exceptions 415
Consequences of close company status 416 31 Inheritance tax 490
Companies with investment business 419 Chargeable transfers of value 490
Choice of business medium 420 Exempt transfers 492
Incorporation 425 Potentially exempt transfers 494
IHT payable on chargeable lifetime
28 Groups of companies and
transfers 496
reconstructions 428
IHT payable on death 498
Related 51% group companies 428
Valuation 504
51% groups 430
Business property relief 506
Transfer pricing 431
Agricultural property relief 507
75% groups 432
Administration of IHT 507
Group relief 433
Transfer of chargeable assets within 32 Overseas aspects of taxation 511
a group 436 Residence and domicile 511
Capital losses 438 Income tax - general rules 514
Consortia 439 Double taxation relief 515
Proposed restriction on interest relief 441 Income from employment 516
Company reconstructions 441 Trading income 518
Income from property and investments 519
Review questions (Set C) 444
Capital gains tax - general rules 520
Inheritance tax - general rules 521
Part 4 Miscellaneous Corporation tax - general rules 521
Controlled foreign companies 524
29 Value added tax (1) 453 Double taxation relief for companies 525
The principle of VAT 453 Diverted profits tax 529
Taxable persons 454
Taxable supplies 454 Review questions (Set D) 532
Exempt supplies 456
Reduced rate supplies 457 Part 5 Answers
Zero rate supplies 457
The value of a supply 458 Answers to exercises 541
Imports and exports 460 Answers to review questions 593
Registration 463
Index 605
Deregistration 468

viii
 Preface

The main aim of this book is to describe the UK taxation system in sufficient depth and
with sufficient clarity to meet the needs of those undertaking a first course of study in
taxation. The book has not been written with any specific syllabus i n mind but should be
useful to anyone who is studying taxation as part of a university or college course in
accounting, finance or business studies. The book should also be of value to students who
are preparing for the taxation examinations of the profess ional accounting bodies. A list of
relevant examinations is given on the back cover of the book.
Every effort has been made to explain the tax system as clearly as possible. There are
numerous worked examples and each chapter (except Chapter 1) concludes w ith a set of
exercises which thoroughly test the reader's grasp of the new topics introduced in that
chapter. The book also contains four sets of review questions, drawn mainly from the past
examination papers of the professional accounting bodies. The sol utions to most of these
exercises and questions are located at the back of the book but solutions to those exercises
and questions marked with an asterisk (*) are provided in a separate Instructor's Manual.
This twenty-third edition includes the provision s of Finance Act 2017 , which is based
upon Finance (No. 2) Bill 2017. This Bill was fast -tracked through Parliament before the
June 2017 general election a nd omitted many of the proposals made in the March 2017
Budget. The remaining Budget proposals are explained in the relevant chapters of this
book, but it is made abundantly clear that these are merely proposals and have not yet been
enacted. Some of the more significant areas affected are:
• The timetable for the Making Tax Digital (MTD) project (Chapter1)
• A planned reduction in the dividend allowance (Chapter 2)
• The property and trading income allowances (Chapters 5 and 9)
• T he cash basis for property income (Chapter 5)
• Corporation tax loss reliefs (Chapter 26)
• C orporate interest relief restrictions (Chapter 28)
• The deemed domicile rules (Chapter 32).
The Government has stated that there will be a Summer Finance Bill but (at the time of
writing) it is not known which measures will be included in this Bill and whether the
implementation date of any of the m will be delayed. A n analysis of the Summer Finance
Bill will be made available as soon as possible on the website which accompanies this
book. The website address is www.pearsoned.co.uk/melville.
Alan Melville
June 2017

ix
 Acknowledgements

I would like to thank the following accounting bodies for granting me permission to use
their past examination questions:
! Association of Chartered Certified Accountants (ACCA)
! Chartered Institute of Public Finance and Accountancy (CIPFA)
! Association of Accounting Technicians (AAT).
I must emphasise that the answers provided to these questions are entirely my own and are
not the responsibility of the accounting body concerned. I should also point out that the
questions which are printed in this textbook have been amended in some cases so as to
reflect changes in taxation law which have occurred since those questions were originally
published by the accounting body concerned.
I would also like to thank the Office for National Statistics for granting me permission to
reproduce the table of Retail Price Indices given in Chapter 24.
Please note that, unless material is specifically cited with a source, any company names
used within this text have been created by me and are intended to be fictitious.
Alan Melville
June 2017

x
 Summary of Tax Data

Income Tax
2017-18 2016-17
TAX RATES AND BANDS
Basic rate 20% 20%
Higher rate 40% 40%
Additional rate 45% 45%
Basic rate limit £33,500† £32,000
Higher rate limit £150,000 £150,000
Starting rate for savings 0% 0%
Starting rate limit for savings £5,000 £5,000
Personal savings allowance (maximum) £1,000 £1,000
Dividend allowance £5,000‡ £5,000‡
† Basic rate limit applicable to non-savings income of Scottish
taxpayers in 2017-18 is £31,500
‡ Rates of tax on dividends in both years are 7.5%, 32.5% and 38.1%

ALLOWANCES £ £
Personal allowance 11,500 11,000
Marriage allowance 1,150 1,100
Blind person's allowance 2,320 2,290
Married couple's allowance:
Born before 6 April 1935 8,445 8,355
Minimum amount 3,260 3,220
Income limit for basic personal allowance 100,000 100,000
Income limit for married couple's allowance 28,000 27,700
CAR AND FUEL BENEFIT
Not exceeding 50g/km 9% 7%
51g/km to 75g/km 13% 11%
76g/km to 94g/km 17% 15%
95g/km 18% 16%
Each additional 5g/km +1% +1%
Maximum charge 37% 37%
Amount used in car fuel benefit calculation £22,600 £22,200
PENSION SCHEMES £ £
Annual allowance 40,000 40,000
Lifetime allowance 1,000,000 1,000,000

xi
Summary of Tax Data

Capital Allowances
Writing Down Allowance (WDA)
Main pool of plant and machinery 18%
Special rate pool of plant and machinery 8%
Annual Investment Allowance (AIA)
AIA annual limit from 1 January 2016 £200,000
AIA rate 100%
First Year Allowance (FYA) on qualifying plant and machinery
Low emission cars 100%
Gas refuelling equipment† 100%
Energy saving or water efficient technology 100%
Zero-emission goods vehicles 100%
† The Government has proposed that expenditure on charging points for electric
vehicles should also be eligible for a 100% FYA.

National Insurance Contributions

2017-18 2016-17
CLASS 1
Lower earnings limit (weekly) £113 £112
Primary threshold (weekly) £157 £155
Upper earnings limit (weekly) £866 £827
Secondary threshold (weekly) £157 £156
Upper secondary threshold (weekly) £866 £827
Employee contributions
Rate on earnings between primary threshold and UEL 12% 12%
Rate on earnings beyond UEL 2% 2%
Employer contributions
Rate on earnings beyond secondary threshold 13.8% 13.8%
CLASS 1A
Rate 13.8% 13.8%
CLASS 2
Weekly contribution £2.85 £2.80
Small profits threshold £6,025 £5,965
CLASS 3
Weekly contribution £14.25 £14.10
CLASS 4
Lower profits limit £8,164 £ 8,060
Upper profits limit £45,000 £43,000
Rate on profits between lower and upper limit 9% 9%
Rate on profits beyond upper limit 2% 2%

xii
 Summary of Tax Data

Capital Gains Tax

2017-18 2016-17
Standard rate† 10% 10%
Higher rate† 20% 20%
Entrepreneurs' relief rate 10% 10%
Entrepreneurs' relief lifetime limit £10,000,000 £10,000,000
Annual exempt amount £11,300 £11,100
† Taxable gains on the disposal of residential property are taxed at 18% and 28%

Corporation Tax
Financial Year FY2017 FY2016 FY2015 FY2014
Main rate 19% 20% 20% 21%
Small profits rate - - - 20%
Lower limit - - - £300,000
Upper limit - - - £1,500,000
Marginal relief fraction - - - 1/400
Note:
The main rate for FY2018 is 19%.

Inheritance Tax
Date of transfer Nil rate Rate on life- Rate Lower
band time transfers on death rate
6 April 2006 to 5 April 2007 0 - £285,000 20% 40% -
6 April 2007 to 5 April 2008 0 - £300,000 20% 40% -
6 April 2008 to 5 April 2009 0 - £312,000 20% 40% -
6 April 2009 to 5 April 2012 0 - £325,000 20% 40% -
6 April 2012 to 5 April 2018 0 - £325,000 20% 40% 36%
Note:
The main residence nil rate band for 2017-18 is £100,000.

Value Added Tax

Standard rate† 20% (from 4 January 2011)
Reduced rate 5%
Registration threshold £85,000 (from 1 April 2017)
Deregistration threshold £83,000 (from 1 April 2017)
†Standard rate 17.5% prior to 4 January 2011

xiii
Part 1

INCOME TAX AND

NATIONAL INSURANCE
 Chapter 1

Introduction to the UK tax

system

Introduction
The purpose of this first chapter is to provide an overview of the UK tax system. The
principal UK taxes are introduced and classified and the main sources of taxation law are
explained. This chapter also deals with:
(a) the structure and functions of Her Majesty's Revenue and Customs (HMRC) which is
the organisation responsible for the administration of the UK tax system
(b) the annual procedure which is used to determine the tax liability of an ind ividual.
The chapter concludes by distinguishing between tax avoidance and tax evasion.

UK taxes

The UK taxation system is composed of a number of different taxes, some of which are
direct taxes and some of which are indirect taxes:
(a) Direct taxes are charged on income, profits or other gains and are either deducted at
source or paid directly to the tax authorities. The main direct taxes which are payable
by individuals are income tax, capital gains tax and inheritance tax. The main direct
tax payable by companies is corporation tax. All of these taxes are administered by
HM Revenue and Customs (HMRC), which was formed in April 2005 when the
Inland Revenue and HM Customs and Excise were merged. National Insurance
contributions, which can also be looked upo n as a form of direct taxation, are
administered by the NICs and Employer Office of HMRC.
(b) Indirect taxes are taxes on spending. They are charged when a taxpayer buys an item
and are paid to the vendor as part of the purchase price of the item. It is th en the
vendor's duty to pass the tax on to the tax authorities. Indirect taxes include value
added tax (VAT), stamp duty, customs duties and the excise duties levied on alcohol,
tobacco and petrol. The only indirect tax considered in this book is VAT, whic h is
also administered by HM Revenue and Customs.

3
PART 1: Income Tax and National Insurance

Sources of tax law

There is no single source of UK tax law. The basic rules are laid down in Acts of
Parliament but it is left to the courts to interpret these Acts and to provide much of the
detail of the tax system. In addition, HMRC issues a variety of statements, notices and
leaflets which explain how the law is implemented in practice. These statements have no
legal backing but they explain the tax authorities' interpretation of the law and will be
adhered to unless successfully challenged in the courts.

Statute law
The basic rules of the UK tax system are embodied in a number of tax statutes or Acts of
Parliament. The main statutes currently in force for each tax are as follows:
Tax Statute Abbreviation
Income tax Capital Allowances Act 2001 CAA 2001
Income Tax (Earnings and Pensions) Act 2003 ITEPA 2003
Income Tax (Trading and Other Income) Act 2005 ITTOIA 2005
Income Tax Act 2007 ITA 2007
National Insurance Social Security Contributions and Benefits Act 1992 SSCBA 1992
Capital gains tax Taxation of Chargeable Gains Act 1992 TCGA 1992
Inheritance tax Inheritance Tax Act 1984 IHTA 1984
Corporation tax Taxation of Chargeable Gains Act 1992 TCGA 1992
Capital Allowances Act 2001 CAA 2001
Corporation Tax Act 2009 CTA 2009
Corporation Tax Act 2010 CTA 2010
Overseas aspects of tax Taxation (International and Other Provisions) Act 2010 TIOPA 2010
Value added tax Value Added Tax Act 1994 VATA 1994
Administration of } Taxes Management Act 1970 TMA 1970
the tax system } Customs and Excise Management Act 1979 CEMA 1979
These statutes are amended each year by the annual Finance Act, which is based upon the
Budget proposals put forward by the Chancellor of the Exchequer. Some of the tax statutes
provide for the making of detailed regulations by statutory instrument. A statutory
instrument (SI) is a document which is laid before Parliament and then auto matically
becomes law within a stated period unless any objections are raised to it.

European Union law

Membership of the European Union (EU) involves adherence to EU law †. Member states
are not required to adopt a common system of taxation but some parts of the UK system
are nonetheless influenced by EU requirements. At present, the main impact is on VAT,
where the prevailing legislation takes the form of EU Directives. These are binding on the
UK and dictate the results which the internal legislation of the UK must bring about.

4
 CHAPTER 1: Introduction to the UK Tax System

Additionally, EU "State aid" approval must sometimes be sought for amendments to UK

tax-advantaged schemes such as the Enterprise Investment Scheme (see Chapter 6) or the
R&D tax credits scheme (see Chapter 23). Furthermore, decisions made in the European
courts may trigger changes to UK tax law, as occurred in relation to the ta x treatment o f
the losses of overseas subsidiary companies (see Chapter 32).
† In view of the Referendum result on 23 June 2016, it seems safe to say that EU influence over the
UK tax system will eventually cease to exist.

Case law
Over the years, taxpayers and the tax authorities have frequently disagreed over the
interpretation of the tax Acts. As a result, many thousands of tax cases have been brought
before the courts. The decisions made by judges in these cases form an important part of
the tax law of the UK and some of the more significant cases are referred to in this book.

Statements made by the tax authorities

The main statements and other documents produced by HM Revenue and Customs as a
guide to the law on taxation are as follows:
(a) Statements of Practice . A Statement of Practice (SP) sets out the HMRC inter -
pretation of tax legislation and clarifies the way in which the law will be applied in
practice. For example, SP 4/97 (the fourth SP issued in 1997) deals with the taxation
treatment of commissions, cashbacks and discounts.
(b) Extra-Statutory Concessions . An Extra -Statutory Concession (ESC) consists of a
relaxation which gives taxpayers a reduction in liability to which they are not entitled
under the strict letter of the law. In general, concessions are made so as to resolve
anomalies or relieve hardship. For example, ESC A91 deals with the taxation treat-
ment of living accommodation provided by reason of employment .
A process of giving statutory effect to certain ESCs is currently underway. This is
generally being done by means of statutory instruments.
(c) Announcements. Announcements (and other notices and documents ) are issued by
HMRC throughout the year on a wide variety of tax -related subjects. Of especial
interest are the documents which are issued on Budget day and which provide a
detailed explanation of the Budget proposals.
(d) Internal Guidance Manuals . HMRC produces a comprehensive set of internal tax
manuals for the guidance of its own officers. These manuals may be accessed on the
HMRC website (see below).
(e) Explanatory publications. Leaflets, factsheets and booklets are aimed at the general
public and explain the tax system in non -technical language. These can usually be
accessed online, though some are still available in printed form.
Most of the above information is now available on the HMRC website, the address of
which is www.gov.uk/government/organisations/hm-revenue-customs.

5
PART 1: Income Tax and National Insurance

The tax year

The changes to the tax system that are proposed in the annual Budget speech † are usually
intended to take effect as from the start of the next tax year. Tax years for individuals and
for companies are identified as follows:
(a) For individuals, a tax year runs from 6 April to the following 5 Ap ril. For instance,
tax year 2016 -17 began on 6 April 2016 and ended on 5 April 201 7. Tax years are
also referred to as fiscal years or years of assessment.
(b) For companies, a corporation tax financial year runs from 1 April to the following 31
March and is identified by the year in which it begins. For instance, he
t financial year
referred to as FY2016 began on 1 April 2016 and ended on 31 March 2017.
This book takes into account the provisions of Finance Act 2017 (which is based on the
March 2017 ‡ Budget) and describes the UK taxa tion system for fiscal year 2017 -18 and
corporation tax financial year FY2017.
† The Budget traditionally takes place in March but is now being moved back to the Autumn of the
previous year. The final Spring Budget occurred in March 2017. The first Autumn Budget will
occur in Autumn 2017 and will lay out the Government's tax plans for the following tax year.
‡ Many of the proposals made in the March 2017 Budget were removed from the ensuing Finance
Bill so as to expe dite the Bill's progress through Parliament before the general electio n of June
2017. At the time of writing , it seems likely that these proposals will be re -introduced and will
form the basis of a second Finance Act in 2017. Further information will be made available on
the website which accompanies this book. The address is www.pearsoned.co.uk/melville.

Structure of HM Revenue and Customs

Her Majesty's Revenue and Customs (HMRC) consists of a large body of civil servants
headed by the Commissioners for Revenue and Customs . The Commissioners are
appointed by Her Majesty The Queen in accordance with recommendations made by the
Treasury. This Government department has overall responsibility for the public finances
of the UK and is managed by the Chancellor of the Exchequer . The main duties of the
Commissioners for Revenue and Customs are as follows:
(a) to implement the law relating to direct and indirect taxation
(b) to provide advice to the Chancellor of the Exchequer on taxation matters
(c) to administer the divisions and offices into which HMRC is organised.
The routine work of H MRC is carried out by officials known as Officers of Revenue and
Customs. With regard to direct taxation, the main fu nction of these officials is generally to
check a taxpayer's own self -assessment of the tax liability (see below) and then to ensure
that t he correct amount of tax is paid. The functions of HMRC with regard to indirect
taxation (and VAT in particular) are explained later in this book (see Chapter 30).

6
 CHAPTER 1: Introduction to the UK Tax System

HMRC has specialist offices which deal with such matters as pension schemes, charities
and so forth but most of the day-to-day work relating to direct taxation takes place in local
area offices. These offices are responsible for routine assessment and collection and for
ensuring that taxpaye rs comply with tax regulations. At present, HMRC has 170 local
offices but these are to be consolidated into 13 regional centres over the next ten years.
Support for taxpayers who need help with their tax affairs is provided by means of
specialist expert advice either given over the telephone or delivered by mobile advisors at
convenient locations in the community or at a taxpayer's home or workplace.

Administration of the tax system

The remainder of this chapter describes the administration system which is used to assess
an individual's liability to income tax and capital gains tax in each tax year. This system is
known as "Self Assessment". Under this system, the taxpayer ( not HMRC) is primarily
responsible for ensuring that:
(a) the tax liability for each tax year is properly assessed, and
(b) the correct amount of tax is paid on the due date or dates.
Later chapters of this book explain the administration systems which are used for the
purposes of corporation tax, inheritance tax and VAT.

Self Assessment

If an individual's tax liability for a tax year cannot b e collected entirely by deduction at
source (see Chapter 2) or via the PAYE system (see Chapter 7), then the liability must be
formally assessed. The starting point in the assessment process is usually the completion
of a self assessment tax return. The annual procedure is as follows:
(a) Tax returns†‡ are normally issued in April each year to those taxpayers who are likely
to need them. Each tax return includes a formal notice requiring a return to be made
and delivered to HMRC. Paper tax returns are not sent to taxpayers who submitted
the previous year's return electronically (see below) but such taxpayers are still sent a
notice requiring a return to be made and can request a paper tax return if they so wish.
Returns can also be downloaded and printed from the HMRC website.
† As from tax year 2016-17, HMRC is empowered to make an assessment of an individual's income
tax or capital gains tax liability without that person being first required to complete a tax return.
This "simple assessment" procedure may be used where HMRC already has sufficient information
about the individual to make the assessment.
‡ By 2020, the Government intends to replace tax returns with online "digital tax accounts" as part
of the "Making Tax Digital" project (see later in this chapter).

7
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