Tax: Principles for Planning, Compliance and Decision Making
What the exam tests in tax
Tax appears as a business constraint and a cash-flow variable. You need to compute tax-adjusted profits and cash flows, understand timing differences, and recognise how tax rules affect investment, pricing and financing decisions.
Core rules and concepts
- Taxable profit is accounting profit adjusted for disallowable expenses and tax incentives such as capital allowances.
- Depreciation is usually disallowed; capital allowances replace it. The timing difference creates deferred tax.
- Permanent differences, for example disallowable entertaining, affect the effective tax rate; temporary differences reverse over time.
- For investment appraisal, use after-tax cash flows and the tax payment timing. Tax savings from capital allowances are cash inflows.
- VAT is borne by the final consumer; a VAT-registered business acts as a collector. Irrecoverable VAT is a cost.
- Transfer pricing should follow the arm's length principle. Tax avoidance is legal planning within the law; evasion is illegal.
- Tax planning should be considered alongside reputation and ethics, not only cash tax saved.
Worked example
Accounting profit is £500,000. The accounts include depreciation of £60,000 and disallowable business entertaining of £30,000. Tax capital allowances are £80,000. The tax rate is 20%. Reasoning: start with £500,000. Add back disallowable entertaining £30,000 and depreciation £60,000 because neither is deductible. Deduct capital allowances £80,000. Taxable profit = 500,000 + 30,000 + 60,000 - 80,000 = £510,000. Tax = 20% × £510,000 = £102,000. The £20,000 excess of capital allowances over depreciation is a temporary difference that may create a deferred tax asset or liability depending on the balance sheet position.
Traps that cost marks
- Deducting both depreciation and capital allowances.
- Applying the tax rate to accounting profit without adjustments.
- Ignoring the timing of tax payments in NPV.
- Treating irrecoverable VAT as recoverable.
- Assuming a lower tax rate always makes a project acceptable; after-tax cash flow and timing still drive the decision.