Practice question and answer bank continuation

Arrol and Louisa

Tutorial note. The disadvantage of a loss relief claim against general income can be that it wastes the personal allowance, demonstrated here in the current year. Note how restricting the capital allowances claimed can avoid the wastage of personal allowances.

(a)      Income tax computation for Arrol

                                                      Non-                              savings         Savings Total

income             income                  

£                       £                       £

Earnings: salary        25,000                               car benefit £19,370  34% (W1)       6,586                       fuel benefit £22,100  34%               7,514                    Bank interest £235  100/80                    294

Building society interest £3,005  100/80                                                            3,756

Total income                                                                               39,100               4,050             43,150

Less loss relief against general income (W2)                           (39,100)             (4,050)         (43,150)

Net income                         0            0                0 Income tax liability: nil

Workings

  • Car and fuel benefit

197 g/km is rounded down to 195 g/km. Excess over base figure 195 – 95 = 100 g/km.

100 ÷ 5 = 20. Taxable % = 14 + 20 = 34%.

Partial contributions towards the cost of petrol do not reduce the fuel benefit.

  • The loss available for relief

£

Loss                                                                                                                                  28,652

Capital allowances:  AIA       £(12,800 + 11,960)                                                           24,760

   53,412

 

Loss in 2015/16: £53,412  11/12 (1.5.15 – 5.4.16)                                                   £48,961

(b)       Income tax computation for Louisa

                                                   Non-savings          Savings             Total

income              income                

£                         £                     £

Earnings                                                                                         7,735

Building society interest £5,388 × 100/80                                                             6,735

NS&I interest                                                                                                            1,832

Net income                                                                                    7,735                 8,567           16,302

Less personal allowance                                                              (7,735)               (2,865)       (10,600)

Taxable income                                                                                     0                  5,702             5,702

 

Income tax                                                                                                   £                                     £

Savings starting rate band                                                                     5,000  0%                            0

Basic rate band: savings income                                                              702  20%

5,702

(c)       The loss of 2015/16 remaining unrelieved

£

2015/16 loss available for relief                                                                                                 48,961

Less used in 2015/16 (part (a))             (43,150) Unrelieved balance               5,811 Relief for the remaining loss may be obtained:

  • In 2014/15 against Arrol’s general income
  • Under early trade losses relief against Arrol’s general income for 2012/13, 2013/14 and 2014/15 in that order, or
  • By carry forward loss relief against future profits of the practice.

A claim against general income for 2014/15 or early years trade losses relief will obtain tax relief at the basic rate (as Arrol would have been a basic rate taxpayer given the probable level of investment income, and the reduced salary, in earlier years).

Carry forward loss relief will obtain tax relief in 2017/18 against the trading profits of the year to 30 April 2017 at the higher rate as Arrol’s other income (if similar to 2015/16) will exceed the basic rate band. If any loss remains to be carried forward to 2018/19 it is likely to obtain tax relief at the higher rate, or even the additional rate, as the business is expected to become very profitable.

£24,760 of the loss derives from Arrol making the maximum claim to capital allowances. A proportion of this loss is wasted by being set against income covered by the personal allowance in the current year. Arrol should consider restricting his claim for capital allowances to avoid wastage of personal allowance. Capital allowances not claimed are effectively carried forward in the pool of expenditure, and although they can then only be relieved on a reducing balance basis, relief will be obtained at a higher rate.

10 ABC Partnership and Ernie

Tutorial note. Always divide the profits of a period of account between the partners before you begin allocating them to tax years. In part (b) do not forget to consider national insurance as well as tax, and also non-tax advantages/disadvantages.

   Total  A  B  C  D
   £  £  £  £  £
 Year ending 5 April 2013          
 Salaries  37,000 15,000 12,000  10,000  
 PSR (balance)    65,000  26,000    26,000  13,000  
 Total  102,000  41,000    38,000  23,000  
 Year ending 5 April 2014          
 6 April to 5 July          
 Salaries   9,250  3,750  3,000   2,500  
 PSR (balance)    42,750  17,100    17,100    8,550  
 Total    52,000  20,850    20,100  11,050  
 6 July to 5 April        
 Salaries  16,500    9,000  7,500
 PSR (balance)  139,500      83,700  55,800
 Total  156,000      92,700  63,300
 Totals for the year  208,000  20,850  112,800  74,350
 Year ending 5 April 2015        
 Salaries  22,000    12,000  10,000
 PSR (balance)  104,000    62,400  41,600
 Total  126,000    74,400  51,600

(a)

   Total  A    B  C  D
   £  £    £  £  £
 Year ending 5 April 2016            
 6 April to 5 May            
 Salaries  1,833      1,000  833  
 Balance    13,167      7,900    5,267  
 Total    15,000      8,900    6,100  
 6 May to 5 April            
 Salaries  49,500      16,500   16,500   16,500

Balance                                                 115,500                                69,300

Total                                                      165,000                                85,800

Totals for the year                                180,000                                94,700           57,250       28,050

Taxable trade profits are as follows.            
      A B C D
      £ £ £ £
Year            
2012/13     41,000 38,000 23,000  
2013/14     20,850 112,800 74,350  
2014/15       74,400 51,600  
2015/16       94,700 57,250 28,050

(b)       (i)      If Freda is employed on a salary of £24,500 a year the tax and NI costs and savings will be:

£

Employer’s NI £(24,500 – 8,112)  13.8% = £2,262            less employment allowance of £2,000     262 Employee’s NI £(24,500 – 8,060)  12% 1,973

Income tax payable by Freda £(24,500 – 10,600)  = £13,900  20%                             2,780

Income tax saved by Eric £(24,500 + 262) = 24,762  40%  (9,905) Class 4 NI saved by Eric £(24,500 + 262) = 24,762  2%    (495) Total saving    (5,385)

If Freda is taken on as a partner with a one-third profit share, ie £24,500, the tax and NI costs and savings will be:

£

Class 4 NI payable by Freda £(24,500 – 8,060) = £16,440  9%                                    1,480

Class 2 NI payable by Freda £2.80  52                                                                              146

Income tax payable by Freda £(24,500 – 10,600) = £13,900  20%                              2,780

Income tax saved by Eric £24,500  40%  (9,800) Class 4 NI saved by Eric £24,500  2%    (490) Total saving       (5,884)

In this case the savings are £499 (£5,884 – £5,385) greater because of the reduction in NI contributions due, even after deducting the employment allowance.

(ii)       If Ernie increased Freda’s share of partnership profits so that Ernie did not pay higher rate tax, the savings would be maximised. Freda’s share of profits would be £(73,500 – 31,785 – 10,600) = £31,115. The savings would be:

£

Class 4 NI payable by Freda £(31,115 – 8,060) = £23,055  9%                                    2,075

Class 2 NI payable by Freda £2.80  52                                                                              146

Income tax payable by Freda £(31,115 – 10,600)  = £20,515  20%                             4,103

Income tax saved by Eric £31,115  40%  (12,446) Class 4 NI saved by Eric £31,115  2%     (622) Total saving            (6,744)

Note that unless Ernie’s share of profits is reduced below £42,385 there is no Class 4 NI advantage in increasing Freda’s share of profits because she would pay Class 4 NI at 9% whilst Ernie would only save Class 4 NI at 2%.

In addition to the tax and NI advantages/disadvantages of taking Freda into partnership as opposed to employing her there are other considerations. These include the unlimited liability of partners, employment law, PAYE obligations and an employee’s entitlement to contributory benefits (such as Jobseeker’s Allowance).

11 Susan, Maria and James

Tutorial note. Double tax relief is an important topic which could be examined in the Section A compulsory questions. Take great care when calculating the amount of UK tax on overseas income. The statutory residence test is important. Remember that the tax tables contain useful information to help you determine whether an individual is UK resident or not in a tax year.

  Nonsavings  

Dividend

 

Total

  income income  
  £ £ £
Earnings 22,470    
UK dividends ( 100/90)    10,000  
Overseas property business income  14,705             
Net income  37,175  10,000 47,175
Less personal allowance  (10,600)              
Taxable income

 

  26,575  10,000  36,575
Income tax on non-savings income:         £
£26,575  20%         5,315
Income tax on dividend income:          
£5,210  10%         521
£4,790  32.5%           1,557
           7,393
Less DTR (W)          (4,019)
           3,374
Less tax credit and PAYE £(2,200 + 1,000)          (3,200)
Tax payable

Working

               174
UK tax on overseas income:     Non-savings Dividend
      income income
      £ £
Taxable income     26,575 10,000
Less overseas property business income      (14,705)            
        11,870  10,000
       
Income tax     £
11,870  20%     2,374
  10,000  10%      1,000
 21,870               
Tax on UK income      3,374
Tax on taxable income (above)      (7,393)
UK tax on overseas income       4,019
  • (i) Susan – income tax computation 2015/16

DTR is lower of:

  • UK tax on overseas income £4,019
  • overseas tax £4,705

(ii)       A UK taxpayer can claim relief from UK tax in respect of overseas tax paid by that person. There is a clear requirement in the legislation that the taxpayer should advise HMRC if subsequently the overseas tax is adjusted by the overseas tax authority so that if a DTR claim is rendered excessive an alteration can be made.

The taxpayer must notify HMRC within one year of any adjustment to the amount of overseas tax. So Susan must notify HMRC before 1 November 2018.

Her DTR claim for 2015/16 becomes the lower of:

1    UK tax suffered on overseas income              £4,019 2               overseas tax suffered (£4,705 – 2,600)        £2,105 ie £2,105 not £4,019 as before.

  • Maria is arriving in the UK. She is not automatically non-UK resident during 2015/16 as she is in the UK for 46 days or more. She also does not work full time overseas.

Maria is not automatically UK resident during 2015/16 as she is not in the UK for 183 days or more, she has a home outside the UK in which she is present for at least 30 days, and she does not work in the UK.

Maria’s residence status will therefore be determined by ‘sufficient ties’. Since she is in the UK for between 121 and 182 days, she will be UK resident if she has 2 UK ties. She does have 2 UK ties since she has close family (her spouse) in the UK and accommodation in the UK which is available to her for at least 91 days in the tax year in which she spends at least one night.

Maria is therefore UK resident in the tax year 2015/16.

  • James will be in the UK for 183 days or more during 2016/17 and so will be automatically resident in the UK.

James will be taxed in the UK on his earnings for working in the UK.

If James claims the remittance basis, he will only be taxed in the UK on his earnings for duties carried out in Utopia (because he has been non-UK resident for three consecutive years out of the previous five tax years) and on his Utopian bank interest, to the extent that the income is remitted to the UK. James should therefore try to avoid remitting such income to the UK. He will also lose his personal allowance if he claims the remittance basis.

If James does not claim the remittance basis, he will be taxed on his world-wide income on an arising basis.

12 Sophie

Tutorial note. This question covers the basics of CGT with which you must be completely familiar by the time you sit Paper P6. You are also required to consider how the CGT liability could have been reduced; there are several basic strategies.
  • Summary
  £
 Total gains £(47,000 + 40,000 + 15,750) 102,750
 Less annual exempt amount  (11,100)
 Taxable gains   91,650
   
CGT @ 28% on £91,650   25,662

Workings

  • Painting

The costs of sale (auctioneer’s costs) can be deducted from the sale proceeds.

£

Proceeds                                                                                                                      50,000

Less costs of sale                                                                                                             (500)

Net proceeds of sale                                                                                                    49,500

Less cost         (2,500) Gain        47,000

  • Freehold shop

The transfer of the shop between the spouses is on a no gain/no loss basis. The base cost for Sophie is therefore £45,000. The value of the shop at the transfer is not relevant.

The gain is:

£

Proceeds                                                                                                                      85,000

Less cost       (45,000) Gain        40,000

  • 2 acres of land

This is a part disposal of the land. The fraction of cost used is:

Proceeds of sale

 cost Proceeds of sale value of part remaining

that is:   £11,000 = £2,250

The gain is:

£

Proceeds      18,000  Less cost                 (2,250)  Gain       15,750

  • JKL plc shares

£

Proceeds                                                                                                                     20,000

Less cost        (52,000) Loss       (32,000)

This is a loss on a disposal to a connected person. The loss is only allowable against a gain on a disposal to the same connected person.

  • There are several ways in which Sophie’s CGT liability could have been reduced.
    • Sophie should have sold the JKL plc shares and gifted the proceeds to her son. She would then have generated an allowable loss of £52,000 – £18,000 = £34,000 (assuming she had achieved the same proceeds as did Jason), instead of realising a restricted loss of £32,000 and Jason generating the loss of £2,000 which can only be used if Jason makes capital gains, which is likely to be some time in the future. Sophie would save CGT of £34,000  28% = £9,520.
    • Terry has made no capital gains in 2015/16 so his annual exempt amount of £11,100 is unused and not all of his basic rate band is utilised. Sophie should have transferred one of the assets to Terry so that the gain would be realised in his hands thereby saving CGT of £11,100  28% = £3,108 plus £(31,785 – 30,000) = £1,785  (28 – 18)% = £179, a total saving of £3,287.
    • Sophie has made a part disposal of 2 acres of land. This does not qualify for the small part disposal relief in Sophie’s hands as the proceeds of this disposal plus the proceeds of the disposal of the shop exceed £20,000.

It might, however, have been possible to have transferred the land to Terry so that he could make a disposal which would fall within the limits. Sophie would transfer the land to Terry (at nil gain nil loss). The disposal by Terry would then fall within the small part disposal rules because the proceeds are less than £20,000 and do not exceed 20% of the market value of the entire holding of land prior to the part disposal. Terry may then deduct the proceeds of the land sold from the base cost of the land retained. Sophie would therefore save CGT of £15,750  28% = £4,410.

13 John and Matilda

Tutorial note. The key to a question in parts like this is to ensure that you make an attempt at each individual requirement.

(a)      Total value due to John on takeover

£

Shares 20,000  £4.90            98,000 Cash 20,000  £1.60                32,000                130,000

Cash element exceeds both £3,000 and 5% of £130,000, so there is a part disposal

£

Disposal proceeds (cash)                                                                                                       32,000

Less cost   £40,000                                                                                   (9,846)

Gain                                                                                                                                          22,154

Base cost of Wall plc shares

£(40,000 – 9,846)                                                                                                                 £30,154

(b)       If John had received loan stock instead of cash there would not be an immediately chargeable gain. If the corporate bonds were qualifying corporate bonds the gain of £22,154 would be deferred until the QCBs were sold. This would enable John to sell the QCBs in tranches realising sufficient gains to utilise the annual exempt amount over a couple of years, and preserve brought forward losses.

If the bonds are not QCBs the base cost of the original shares would simply be apportioned between the new shares and bonds, and no gain would arise until the bonds were disposed of. Again, this allows for phased disposals. (c)   Match acquisitions in next 30 days first

1 October 2015

£

Disposal proceeds (£42,000   )                                                                                 26,250

Less cost    (25,750) Gain              500

Then match with share pool

15 May 2008

Shares held after bonus issue 1,800 + 1,800 = 3,600

No change to base cost

£

Disposal proceeds (£42,000  )                                                                               15,750

Less cost (£1,900                                                                                                      (633)

Gain                                                                                                                                        15,117

The total chargeable gain on the sale of Matilda’s shares in Read plc is £15,617 (£500 + £15,117).

  £
Gain 22,154
Less loss brought forward  (11,054)
  11,100
Less annual exempt amount  (11,100)
Taxable gains            0
CGT payable        £nil

(d)       Summary: John

The losses brought forward are only set against gains to bring the gains down to the annual exempt amount.

Loss carried forward £(16,560  11,054)                                                                           £5,506

Summary: Matilda

£

Gain                                                                                                                                       15,617

Less annual exempt amount                                                                                              (11,100)

Taxable gains                                                                                                                          4,517

CGT payable

£4,517  18% (within unused basic rate band of £31,785 – £20,000 = £11,785)               £813

14 Hazel

Tutorial note. This question requires you to write a report so it is important that you did so. Marks may be specifically allocated for report writing or letter writing skills.

Report

To:            Hazel

From:        An Advisor

Date:         [date]

Subject:   Incorporation of your business

  • If you sell your business to a company you will make a disposal of all the business’s assets. You can avoid an immediate charge to capital gains tax through incorporation relief.

This relief applies automatically where:

  • There is a transfer of a going concern
  • All assets (or all the assets except cash) are transferred  The consideration is wholly or partly for shares

An election can be made to disapply the relief, for example if you wished to use another relief (see further below).

  • The gains on disposal are wholly deferred against the cost of shares received on incorporation where all of the consideration is received as shares.

If any of the consideration is received in cash (or loan notes or left on a loan account) a proportion of the gain will remain chargeable.

The maximum amount of cash that you could receive without triggering a charge to capital gains tax is £21,180 (see Appendix).

  • The disadvantages to incorporation relief are as follows:
    • The cost of the shares that you will be able to use when you eventually dispose of the shares will be reduced by the relief given to £64,320 (£133,820 – £69,500).
    • You have to transfer all the assets (with the exception of cash) even if you wanted to retain, for example, the freehold shop outside the company
    • The transfer of assets (such as the shop) may lead to a double tax charge in the future as corporation tax would be due from the company on the disposal of the asset and then when the proceeds are paid out to you as the shareholder there may be a further tax charge (either income tax or capital gains tax depending on how the proceeds are extracted from the company).
  • As an alternative, you could consider gift relief. In this case you would need to gift the business’s assets to the company. You would therefore be able to choose which assets to transfer and which to retain, eg the shop.

Gift relief defers your gain by reducing the base cost of the asset for company. The company then has a lower cost when it comes to sell the assets and therefore a higher gain.

Appendix – Maximum non-share consideration to take on incorporation

£

Total consideration                                                                                                                    155,000

Less: share consideration (W1)                                                                                              (133,820)

Cash consideration                                                                                                                       21,180

Workings

  • Share consideration

£

We want relief of (W2) :                                                                                                 69,500

Gain before reliefs is:                                                                                                      80,500

Total consideration is:                                                                                                   155,000

Therefore share consideration must be:

 £155,000                                                                                                    £133,820

  • Relief to bring gain to nil

£

Total gain:

Goodwill                                                                                                               30,000

Property                                                                                                               50,600

80,600

Less incorporation relief (balance)                                                                                      )

Gain

Less annual exempt amount   (11,100) Taxable gain                    Nil

 

15 Wendy, Henry and Frank

Tutorial note. In part (c), no further absence can be counted as deemed occupation because Frank did not go back to live in the house (compare absence followed by occupation between 1.8.96 and 31.1.07). Note also how the election as to which house is used as the PPR can be advantageous.

  • Wendy

The lease

£

Proceeds                                                                                                                                  30,750

Less 64.116 (16 years)  £8,000                                                                         (6,383)

80.361 (24½ years)

Gain                                                                                                                                          24,367

The percentage for 24½ years is 79.622 + (81.100  79.622)  6/12 = 80.361.

  • Henry

2015/16

No CGT event on the damage to the factory.

2016/17

Receipt of compensation is treated as part disposal. The amount not used in restoration is not

‘small’. The restoration must also be taken into account.

£

Amount not used in restoration £(20,000 – 15,000)                                                          5,000

Less cost plus restoration

5,000

5,000 250,000  £(150,000 + 15,000)                                                             (3,235 )

Gain                                                                                                                                        1,765

2017/18

Sale of factory

£

Sale proceeds                                                                                                                       260,000

Less cost £(150,000 + 15,000 – 3,235 – 15,000)  (146,765) Gain   113,235

(c)        Frank

  • Gain on sale

£

Proceeds       180,000  Less cost               (50,000)  Gain before PPR exemption         130,000

Exempt gain (W): 16 12  £130,000                                                                    ((102,143)

21

Gain                                                                                                                             27,857

Working

 Principal private residence relief                                          Exempt years  Chargeable years

1.8.94 – 31.1.99 (actual occupation)                                               4½

1.2.99 – 31.1.03 (up to 4 yrs due to place of work –           4              not employed abroad)

1.2.03 – 31.1.04 (up to 3 years any other reason)                          1

1.2.04 – 31.7.09 (actual occupation)                                               5½

1.8.09 – 31.1.14 (not followed by actual occupation)                                                         

1.2.14 – 31.7.15 (last 18 months)                                                    1½

Totals                                                                                               16½                                

  • If Frank had moved back into his house before it was sold, then the two years from 1.8.09 to 31.7.11 would have been treated as a period of occupation (balance of up to three years for any other reason) since Frank had re-occupied the property after the period of absence. The exempt portion of the gain would have increased to 18½/21  £130,000 = £114,524, leaving a chargeable gain of £15,476.
  • When Frank inherited the house from his sister he had two residences available. He should have moved back to his own house for a few months. He should then have returned to his sister’s house, electing for that to be treated as his PPR. Any remaining months before his old house was sold would be covered by the exemption for the last 18 months.

Provided the sister’s house was sold within 18 months of her death any gain would also be covered by the exemption for the last 18 months.

16 Mark and Sarah

Tutorial note. Administration should be a very familiar topic from F6. It can be examined in the compulsory Section A questions so you should ensure that you have a thorough knowledge of it.

(a)       Returns

For the tax year 2015/16, a tax return must usually be submitted by 31 January 2017 (electronically) or 31 October 2016 (paper).

However, if the notice to file the tax return is issued by HMRC to the taxpayer after 31 July 2016 but on or before 31 October 2016, the latest filing date is the end of 3 months following the notice if a paper return filed. The latest date for filing electronically remains 31 January 2017. If the notice to file the tax return is issued by HMRC after 31 October 2016, the latest filing date is the end of 3 months following the notice. This applies whether the return is filed electronically or on paper.

An individual is liable to a penalty where a tax return is filed after the due filing date. The penalty date is the date on which the return will be overdue (ie the date after the due filing date). The initial penalty for late filing of the return is £100.

If the failure continues after the end of the period of three months starting with the penalty date, HMRC may give the individual notice specifying that a daily penalty of £10 is payable for a maximum of 90 days.

If the failure continues after the end of the period of six months starting with the penalty date, a further penalty is payable. This penalty is the greater of 5% of the tax liability which would have been shown in the return and £300.

If the failure continues after the end of the period of 12 months starting with the penalty date, a further penalty is payable. This penalty is determined in accordance with the taxpayer’s conduct in withholding information which would enable or assist HMRC in assessing the taxpayer’s liability to tax. The penalty is between 5% and 100% of the tax liability which would have been shown on the return depends on the taxpayer’s conduct in withholding information which would enable or assist HMRC in assessing the taxpayer’s liability to tax. The penalty is computed as follows:

Type of conduct Penalty
Deliberate and concealed Greater of:

•          100% of tax liability which would have been shown on return; and

•          £300

Deliberate not concealed Greater of:

•          70% of tax liability which would have been shown on return; and

•          £300

Any other case (eg careless) Greater of:

•          5% of tax liability which would have been shown on return; and

•          £300

Self assessment of tax

If the taxpayer files his return electronically, the calculation of the tax liability is made automatically when the return is made online.

If the taxpayer files his return non-electronically on or before 31 October 2016 (or within two months of the notice if the notice is issued after 31 August 2016), the taxpayer may ask HMRC to make the tax calculation. Otherwise, the taxpayer must make the calculation.  Payments of tax

An individual may be required to make payments on account of his income tax and Class 4 NICs liability for 2015/16 on 31 January 2016 and 31 July 2016. A balancing payment of income tax and Class 4 NICs, and the whole of the individual’s capital gains tax liability, is due on 31 January 2017. Class 2 NICs will also be due on 31 January 2017.

Payments on account for 2015/16 are required where the individual’s income tax and Class 4 NICs due in 2014/15 exceed the amount deducted at source: the excess is called the ‘relevant amount’. The payments on account are 50% of the relevant amount for 2014/15. Payments on account are not required if the relevant amount is less than £1,000 nor if the tax deducted at source in 2014/15 was 80% or more of the total tax liability of that year.

The taxpayer may make a claim to reduce his payments on account if he expects his 2015/16 tax liability to be lower than his 2014/15 liability. The payments may be reduced to a stated amount or to nil. The claim must state why the taxpayer believes his liability will be lower. If the eventual liability is more than estimated, interest will be charged on the over-reduction. If the claim was made fraudulently or negligently, a penalty up to the amount of the over-reduction may be imposed.

Interest on overdue tax is charged on all unpaid tax from the due date. Where the balance of the tax due on 31 January 2017 is not paid within 30 days (the penalty date), a penalty for later payment is charged. Where payment is made within five months of the penalty date, the penalty will be 5% of the unpaid tax, rising to 10% where the payment is made more than five months but less than 11 months after the penalty date and 15% thereafter.

(b)       Mark

Due dates of tax – 2015/16

Payments made                     Paid                            No claim to reduce             Due date

                                                                   payments on account                             

£                                                                                   £

4,500             28 February 2016               6,000    31 January 2016  4,500       31 August 2016               6,000    31 July 2016

   4,000                 31 March 2017                                  1,000                         31 January 2017

 13,000                                                                          13,000

Interest due

Payments on account:

£

£4,500  1/12  3%                                                                                                                            11

£4,500  1/12  3%                                                                                                                            11

£1,500  14/12  3%    52 £1,500  8/12  3%      30

Final payment:

£1,000  2/12  3%                                                                                                                               5

 109

(c)        Sarah’s tax return was prepared in accordance with the practice prevailing at that time. She will therefore be precluded from making a claim for the revised treatment if the court case should go in the taxpayer’s favour.

Sarah is, however, able to amend her tax return at any time up until 31 January 2018. She should therefore file an amendment to her return, using the more favourable treatment.

It is likely that HMRC will open a compliance check enquiry into her tax return, thereby enabling them to amend the return should the taxpayer fail in the Courts. Even at that stage Sarah could appeal against any amendment HMRC made on closing a compliance check enquiry if it was likely that the matter would progress to higher courts.

17 Rodin

Tutorial note. This answer follows the ‘steps’ set out within the text but in a streamlined format which is equally acceptable in the exam.

(a)       IHT paid during Rodin‘s lifetime was as follows.

25.12.06

  £
Gift  60,000
Less: A/E (2006/07)  (3,000)
           A/E (2005/06) b/f   (3,000)
PET  54,000

This gift was a PET so no lifetime tax was due.

21.1.09

No gross chargeable transfers were made in the seven years prior to 21.1.09 so all of the nil band remained available for use.

The gross chargeable transfer was: £315,000 + £750 = £315,750.

Check: tax £(315,750 – 312,000) = £3,750  20% = £750.

20.8.12

 
  £
Gift  31,000
Less: A/E (2012/13)  (3,000)
           A/E (2011/12) b/f   (3,000)
PET  25,000
This means the IHT paid by Rodin was:  
  £
Gift  321,000
Less: A/E (2008/09)  (3,000)
                      A/E (2007/08) b/f     (3,000)
 

 

 315,000
  £
            IHT       £312,000          0% = 0
                           £3,000           20/80 =  750
                        £315,000  750

This was a PET so no lifetime tax was due.

19.6.13

Gross chargeable transfers of £315,750 had been made in the seven years prior to 19.6.13 so

£(325,000 – 315,750) = £9,250 of the nil band remains and the lifetime IHT due was:

£

Gift                                                                                                                                           88,000

Less A/E (2013/14)                                                                                                                       )

      £
IHT    £9,250   0% = 0
   £75,750   20% =  15,150
   £85,000    15,150

 

1.8.15  
  £
 Gift  73,000
 Less: A/E (2015/16)  (3,000)
          A/E (2014/15) b/f   (3,000)
 PET  67,000

This was a PET so no lifetime tax was due.

1.9.15

This was an exempt transfer to Rodin’s UK domiciled spouse so no lifetime tax was due.

IHT due as a result of death.

As a result of death, IHT will be due on transfers made in the seven years before the death.

Lifetime transfers

25.12.06

This PET was made more than seven years before death, so no IHT arises as a result of death.

21.1.09

Gross transfer                                                                                                                         £315,750

None of the nil band had been used in calculating death tax in the seven years before 21.1.09 so the IHT due on death is nil because the transfer is completely covered by the nil band at death of £325,000. There is no repayment of lifetime tax.

20.8.12

Gross chargeable transfers of £315,750 had been made in the seven years prior to 20.8.12 so

£(325,000 – 315,750) = £9,250 of the nil band remains and the death IHT due is

£

PET                                                                                                                                            25,000

££

IHT                 £9,250                0% =    0              £15,750                40% =               6,300

 £25,000                                                                                                                         6,300

Less taper relief @ 20% (3-4 years)       (1,260) IHT payable by daughter (80%)           5,040

19.6.13

All of the nil band has been used in calculating death tax on the gifts made in the seven years prior to 19.6.13, so the death tax due on this gift is:

Gross chargeable transfer                                                                                                        £85,000

 

£

£85,000  40% =      34,000 Less lifetime tax     (15,150) Tax due on death (no taper relief as death within 3 years of gift)   18,850

1.8.15

No nil band remains so IHT due on this now chargeable PET is:

PET (valued at 1.8.15)                                                                                                              £67,000

£67,000  40%                                                                                                                        £26,800

No taper relief as death occurs within 3 years of the gift.

1.9.15

No IHT arises on an exempt transfer to a spouse.

  • If Rodin’s wife had not been domiciled in the UK at the time of the transfer to her, only the first £325,000 of the transfer would have been exempt. The balance of the transfer would still be a PET, so there would be no IHT to pay unless Rodin died within seven years. The IHT that would be due following Rodin’s death would be £(400,000 – 325,000)  40% = £30,000.
  • The gift by Rodin’s cousin into the discretionary trust is a CLT which is in excess of the nil rate threshold of £325,000. He should therefore make this gift first to ensure that the annual exemption for the current year and the previous year are set against this transfer, so reducing the amount of lifetime IHT payable. If Rodin’s cousin pays the tax the gift would need to be grossed up, so the immediate IHT saving would be £3,000  2  20/80 = £1,500, whereas if the trustees paid the tax the saving would be £3,000  2  20% = £1,200.

The gifts to the two children are PETs and no tax will be payable unless Rodin’s cousin dies within seven years of the gifts.

Rodin’s cousin could delay his gift to his daughter until her marriage so that he can utilise the marriage exemption. For a parent the exemption is £5,000. Should Rodin’s cousin die within three years of the gift this will save IHT of £5,000  40% = £2,000, with reduced savings (because of taper relief) if death is between three and seven years from the gift. There is a small element of risk should Rodin’s cousin die more than seven years after the gift to the son, but within seven years of the gift to the daughter.

18 Hubert

Tutorial note. Note the different valuation rules for CGT and IHT. The shares are valued at market value for CGT purposes. For IHT purposes the diminution in value principle is used to value the shares.

(a)      Capital gains tax liability

£

Gain on shares (W)                                                                                                                   30,889

Less annual exempt amount  (11,100) Taxable gain          19,789

The CGT is £19,789  10% =  £1,979.

Inheritance tax liability

The gift to the discretionary trust is a chargeable lifetime transfer. As he pays the tax, grossing up is necessary. Two annual exemptions of £3,000 each (for 2015/16 and 2014/15) are available to reduce the net transfer.

£

Transfer                                                                                                                                  349,000

Less: A/E (2015/16)                (3,000)   A/E (2014/15) b/f                  (3,000) Net transfer     343,000

There have been no previous transfers so all of the nil band remains available for use in calculating the IHT on this transfer.

£

£325,000          0%                                                                                                           0

£18,000           20/80

£343,000

Gross transfer is thus £347,500 (£343,000 + 4,500). The IHT payable by Hubert is £4,500.

Check: tax £(347,500 – 325,000) = £22,500  20% = £4,500.

The gift to Maxine on 1 April 2016 is a potentially exempt transfer so no tax is due during Hubert’s lifetime.

Working

Share Pool

   No. of shares  Cost
     £
 1.11.95 Acquisition  2,200  3,300
 15.6.05 Acquisition  200  1,366
 18.8.11 Acquisition     600   3,000
   3,000  7,666
 1.4.16 Disposal  (2,000)  (5,111)
 c/f

 

 1,000   2,555
     £
 Disposal proceeds (2,000  £18) (market value)    36,000

Less cost    )  Gain qualifying for entrepreneurs’ relief      Entrepreneurs’ relief applies because

  • there is a disposal of shares in a company which is the individual’s personal company

(owns at least 5% of ordinary share capital); and

  • the individual is an officer of the company; and
  • these conditions were met throughout the period of one year ending with the date of disposal.

(b)       If Hubert was to die on 20 April 2016, the potentially exempt transfer to Maxine on 1 April 2016 would become chargeable. The amount of this transfer, applying both the diminution in value principle and the related property rules (since Rose owns 1,000 shares) is as follows.

  £
Before the transfer, Hubert had 3,000 shares  
in a holding of 3,000 + 1,000 = 4,000 shares (80%), worth £36.67 a share 110,010
After the transfer, Hubert had 1,000 shares  
in a holding of 1,000 + 1,000 = 2,000 shares (40%), worth £18 a share  (18,000)
  92,010
Less actual proceeds  (10,000)
  82,010
Less business property relief: unavailable because shares sold by date  
of Hubert’s death          (0)
Transfer of value (no annual exemptions available)  82,010

On Hubert’s death, his remaining shares would also be valued using the related property rules, as follows.

   £
1,000 shares in a holding of 2,000  
 shares, worth £18 a share  18,000
Less business property relief at 100% (unquoted shares)  (18,000)
             0

The inheritance tax liabilities which would arise on Hubert’s death on 20 April 2016 are as follows.

1 May 2015 transfer

IHT at death (no taper relief – death within 3 years)  
  £
          £325,000           0%  0
           £ 22,500           40%    9,000
 £347,500  9,000
Less    Lifetime tax paid   (4,500)
Tax payable at death 1 April 2016 transfer    4,500
  £
Transfer of value 2016  82,010
Less: A/E (2015/16 – already used)  0
           A/E (2014/15 – already used)           0
   82,010

Gross transfer (valued on 1 May 2015)                                                                           £347,500

All nil band used in previous seven years so IHT due on death is:

£82,010  40% = £32,804

Death estate

£

Shares                                                                                                                                          Nil

Cash                                                                                                                                      40,000

Less    CGT liability                                                                                                               (1,979)

 38,021

IHT at 40% =  £15,208

The trustees of the settlement must pay IHT of £4,500.

Maxine must pay IHT of £32,804.

Hubert’s personal representatives must pay IHT of £15,208.

(c)       Notes for meeting

Immediate gift of shares in Bod Ltd:

  • PET for IHT purposes, only chargeable if Hubert dies within seven years.
  • BPR only available on Hubert’s death within seven years if Roger retains the shares and they are still eligible for BPR.
  • Disposal for CGT purposes. Entrepreneurs’ relief will reduce tax rate. Gift relief will also apply.
  • Loss of influence over running of Bod Ltd; Rose has a 20% holding.

Retention of shares in Bod Ltd until death:

  • BPR likely to be available on Hubert’s death, so no IHT.
  • Tax free uplift to market value at date of death for CGT purposes.
  • Retention of influence over running of Bod Ltd; Hubert and Rose each have a 20% holding.
  • If Roger is involved in the business he may be unhappy not to have received shares whilst his sister purchased shares at an undervalue.

19 Rhys

Tutorial note. Work through the transactions methodically to identify when an IHT charge will arise.

(a)      Death 3 September 2015

RJ discretionary trust

The occasions of charge are:

17 July 2008: CLT by Rhys. If Rhys pays the tax this will be grossed up. The full nil rate band at 17 July 2008 is available. There is no additional tax on Rhys Jones’ death as he survived 7 years from the gift.

5 March 2017: exit charge on the assets distributed. This is calculated using 30% of an assumed rate of tax scaled down by 34/40 to reflect the number of complete quarters that have elapsed since the settlement was created. The assumed rate is calculated using a transfer equal to the initial value of the settlement with prior transfers equal to the chargeable transfers made by Rhys in the seven years prior to the settlement (£nil).

  • July 2018: principal charge calculated using 30% of an assumed rate. The assumed rate is calculated using a transfer equal to the value of the settlement at the date of the anniversary with prior transfers equal to the chargeable transfers made by Rhys in the seven years prior to the settlement (£nil) plus the transfers made on 5 March 2017.
  • April 2021: exit charge on the assets distributed. This is calculated using 30% of the assumed rate of tax calculated at the last principal charge scaled down by 11/40 to reflect the number of complete quarters that have elapsed since the anniversary.

Rhys discretionary will trust

3 September 2015: charge on death estate. The full nil rate band is available as the RJ discretionary trust was set up more than seven years earlier.

28 February 2020: exit charge on death of Blodwen causing capital to pass to her children (the actual date of distribution is not relevant). This is calculated using 30% of an assumed rate of tax scaled down by 17/40 to reflect the number of complete quarters that have elapsed since Rhys Jones’ death. The assumed rate is calculated using a transfer equal to the initial value of the settlement with prior transfers equal to the chargeable transfers made by Rhys in the seven years prior to the death (£nil).  (b)  Death 3 July 2015

RJ discretionary trust

If Rhys dies on 3 July 2015 this will be within seven years of the settlement and there may be additional IHT to pay by the trustees. Taper relief will be available to reduce the death tax and any lifetime tax paid will be deducted.

Rhys discretionary will trust

As death occurred within seven years of the transfer to the RJ discretionary trust, the available nil rate band at death will be reduced by the transfer of value and this will increase the IHT due on the death estate.

When computing the exit charge due on death of Blodwen on 28 February 2020 the chargeable lifetime transfer by Rhys to the RJ discretionary trust will be an assumed prior transfer, so increasing the rate of IHT payable on the exit charge.

20 Dan

Tutorial note. Stamp taxes are a small part of the P6(UK) syllabus but can yield valuable marks. There is useful information in the rates and allowances table available in the exam.
  • Stamp duty land tax payable is £520,000  4% = £20,800. Land transaction return should be filed with HMRC (Stamp Taxes) and SDLT paid both within 30 days of the purchase.
  • Stamp duty land tax is payable as follows.

                                                                                                                                       £

£125,000  0%                                                                                                                 0

£125,000 (£250,000 – 125,000)  2%                                                                     2,500

 £350,000 (£600,000 – 250,000)  5%                                                                   17,500

 £600,000                                                                                                                  20,000

SDLT reported and paid as in part (a).

  • Stamp duty payable is £15,000 5% = £75. Stock transfer form should be sent to HMRC (Stamp Taxes) with the stamp duty payable within 30 days of the purchase.
  • Stamp duty reserve tax is £30,000 5% = £150. Stamp duty reserve tax is collected automatically when a transaction is made using CREST.
  • No charge to stamp duty land tax on transfer on divorce. No land transaction return needs to be filed with HMRC (Stamp Taxes) because the transfer is exempt from SDLT.

21 Fraser Ltd

Tutorial note. The first part of this question is revision of material that you should know well from Paper F6. The second part requires you to apply your knowledge to several different proposals.

(a)      Corporation tax computation

£

Trading income (W1)                                                                                                              338,105

Interest income £(6,834 + 2,208)  9,042  Chargeable gains (W3)            35,870

Taxable total profits                                                                                                                383,017

Workings

(1)      Adjusted profit computation

£                      £

Profit before taxation                 413,278 Add: depreciation              13,876   gifts (over £50 each)  2,085   entertaining           969

   16,930                               430,208

Less: dividend including tax credit  1,655   bank interest    6,834   interest from gilts  2,208   surplus on disposal of office building and lease  61,806   capital allowances (W2)  19,600

  (92,103)

Taxable trading profit                                                                                                   338,105

  • Capital allowances

AIA £9,800  2                                                                                              £19,600

  • Chargeable gains

(a)       The lease

£

Proceeds                                                                                                              39,242

Less cost

66.470 ½(68.69766.470)      17.5 years                      (14,583)

£17,500                                                     =

81.100                          25 years                                   

Unindexed gain                                                                                                   24,659

Less indexation allowance to April 2015

0.228  £14,583              (3,325) Chargeable gain    21,334

(b)      The office building

£

Proceeds                                                                                                           117,789

Less cost                                                                                                            (79,000)

Unindexed gain                                                                                                   38,789

Less indexation allowance to August 2015

0.307  £79,000             (24,253) Indexed gain         14,536

Total gains are £(21,334 + 14,536) = £35,870.

(b)       Purchase of office building A

The building will cost £150,000. The two disposals by Fraser Ltd during the year to 31 March 2016 realised proceeds of £157,031, so Fraser Ltd can make a claim to roll over all but £7,031 of the gains realised in the year ended 31 March 2016.

Purchase of office building B

If Fraser Ltd is to use half of the office building itself, the cost of that half will be £200,000, so that full rollover relief will be available. Rollover relief is not available against let property.

Rent received, less property expenses, will be taxed as property income.

Any interest paid on bank borrowings or loan stock would be allowable, either as a trading deduction or as a deduction from interest income, but not as a deduction from property income. It would be necessary to identify how the borrowings had been applied, and to apportion the interest payable between trading and non-trading.

Purchase of subsidiary

If a subsidiary is purchased Fraser Ltd will not be able to roll over any of the gains from the disposals in the year ended 31 March 2016 as shares are not qualifying assets.

No tax relief will be available for the cost of the shares until Fraser Ltd disposes of them, and the disposal may then be exempt as the disposal of a substantial shareholding.

Any interest paid on borrowings for the share purchase will be allowed as a deduction from nontrading interest.

Purchase of patents etc

The tax treatment of patents etc follows the accounting treatment. Fraser Ltd will therefore obtain a deduction for the cost of these intangible fixed assets over their useful lives. As the patents are to be used in the trade the costs will be trading expenses; if Fraser Ltd acquires the subsidiary the patents should therefore also be acquired by the subsidiary.

Equity capital

If Fraser Ltd realises funds through the issue of shares rather than by raising loans, then there will be no interest payments to deduct in the accounts. Investors may require the payment of dividends; these are not tax deductible.

22 Melson Ltd

Tutorial note. Rollover relief is not available to defer the gain arising on the sale of the warehouse or the other properties because they were not used in the trade of Melson Ltd. Watch out for substantial shareholding exemption on a sale of trading company shares.

Chargeable gains computation

  £
 Warehouse (W1)  37,835
 Shop (W2)  38,792
 Office building (W3) 82,175
 Shares (W4)             0
 Chargeable gains  158,802

Workings

  • Warehouse
   £
Proceeds  125,000
Less cost  (65,000)
   60,000

Less indexation allowance  (0.341)  £65,000                                              (22,165)

 37,835

Rollover relief is not available as the old asset was not used by Melson Ltd in its trade.

  • Shop

£

Proceeds                                                                                                                                  75,000

Less cost    (20,000)  extension             (4,000)

51,000

Less indexation allowance

258.0 – 170.1 (0.517)  £20,000                                                                   (10,340)

(0.467)  £4,000                                                                                  (1,868)

38,792

  • Office building

£

Proceeds   180,000  Less cost              )

 

 Less indexation allowance 258.2 – 171.6 (0.505)  £65,000                                  (32,825)

171.6

 82,175

  • Shares

The gain on the disposal of the shares in Leigh Ltd is exempt under the substantial shareholding exemption because:

  • Melson Ltd is a trading company
  • Leigh Ltd is also a trading company
  • Melson Ltd held 10% of the ordinary share capital of Leigh Ltd for a continuous period of twelve months in the two years preceding the disposal

23 Major Ltd

Tutorial note. It is important to distinguish between trading and non-trading loan relationships. Interest on the former is dealt with as trading income whilst interest on the latter is dealt with as interest income.

(a)       Corporation tax

£

Taxable trading income         425,000 Property income   30,000

Capital gains                                                                                                                                 40,000

Total profits                                                                                                                               495,000

Less qualifying charitable donation                                                                                           (3,000)

Less non-trade deficit (£24,000 – £30,000)                        (6,000) Taxable total profits               486,000

Corporation tax

£

£486,000  20%                                                                                                                         97,200

Payment of tax

£

Taxable total profits                                                                                                                   486,000

Add Franked investment income                                                                                                 20,000

Profits                                                                                                                                         506,000

 

Profit threshold £1,500,000  8/12  ½                                                                                   500,000

If Major Ltd was a large company in the previous accounting period, it must pay its corporation tax for the period ending 31 March 2016 in instalments. The amount of the first two instalments is 3  £97,200/8 = £36,450 and the balancing instalment is £24,300. The instalments are due on 14 February 2016, 14 May 2016 and 14 July 2016.

If Major Ltd was not a large company in the previous accounting period it does not have to pay its corporation tax in instalments. Instead the due date for payment of the whole liability is 1 January 2017.

  • To:            The Directors of Major Ltd

From:       Certified Accountant

Date:         31 March 2016

Re:           Tax implications of the loan to Z Ltd becoming irrecoverable

It will not be possible for any amount of the loan written off to be deducted in computing Major Ltd’s trading profits. This means that if the loan is written off in the company’s income statement, the amount written off must be added back to compute trading profits. Instead any amount written off will be treated as a debit on a non-trading loan relationship. This means that it will initially be deducted from income arising on non-trading loan relationships in the same accounting period (if any, given Z Ltd may also be unable to pay interest on the loan). Any overall net deficit can be: (i)        Set against the company’s total profits in the same accounting period, or

  • Set against income from non trading loan relationships arising in the previous twelve months, or
  • Set off against non-trading profits in the following period, or (iv)       Surrendered as group relief.

Signed: Certified Accountant

  • General considerations

Any dividends received on the shares acquired are not subject to corporation tax, but will be taken into account as franked investment income when determining when corporation tax payments are due. Any interest paid on borrowings to fund the purchase would be allowed as a deduction from non-trading interest, and if there is a deficit it can be relieved as described above.

Purchase of 20% holding from a retiring director

If Major Ltd purchases a 20% holding from a retiring director no tax relief will be obtained for the cost of the shares until they are sold. Provided the shares are held for at least twelve months and the target company is a trading company, the conditions for the substantial shareholding exemption to apply are likely to be satisfied so that any gain on disposal would be exempt. Conversely, if the target company collapses the loss would not be allowable. If it appears that the target company is declining it may be worthwhile attempting to sell the shares within twelve months of acquisition to ensure the loss is allowable.

Subscription for 8% holding

As the shareholding will be less than 10%, it will not qualify for the substantial shareholding exemption. If a gain is made on the disposal it will be fully taxable. If there is a loss it will be allowable.

24 Hogg Ltd

Tutorial note. The information required in this question should be very familiar knowledge to you from Paper F6.

  • The due dates for the payment of corporation tax by Hogg Ltd in respect of the year to 31.3.16 are:

£                      £

14 October 2015 (1/4  £500,000)                                                                                          125,000

14 January 2016 (1/4  £500,000)                      125,000 14 April 2016 (1/4  £520,000)        130,000        plus underpaid 2  £(130,000 – 125,000)     10,000

140,000

14 July 2016 (1/4  £520,000)                                                                                                 130,000

1 January 2017 100%  £525,000

– £125,000 – £125,000 – £140,000 – £130,000                                                                        5,000

Total                                                                                                                                           525,000

  • Hogg Ltd’s corporation tax return for the year to 31 March 2016 was due by 31 March 2017, and so the return is more than six months late. Therefore a fixed penalty of £200 is due (or £1,000 if Hog Ltd’s return was late (or never submitted) for each of the preceding two accounting periods).

If Hogg Ltd waited until the submission date of 10 October 2017 to finalise its tax liability and pay any outstanding tax, then £5,000 was unpaid six months after the return was due (30 September 2017), and so a tax geared penalty of 10% (£500) would also arise.

25 Norma

Tutorial note. This question takes a situation of an individual commencing a new trade and contrasts the tax treatment of trading as a company or as an unincorporated business. It is simply a question of applying your knowledge of the tax rules to the given scenario.

 

 Individual      
 Profits/salary  60,000    15,000
 Dividend 48,000/36,000  100/90    53,333 40,000
 Less PA  (10,600)  (10,600)   (10,600)
 Taxable income  49,400  42,733  44,400
 Income tax payable      
 31,785/nil/4,400 @ 20%  6,357   880
 nil/31,785/27,385 @ 10%   3,178 2,738
 17,615/nil/nil @ 40%  7,046    
   (a)  (b)  (c)
   Sole  Dividend  Dividend +
   trader    salary
   £  £  £
 Company      
 Profits  N/A  60,000  60,000
 Less  salary      (15,000)
 Less  employers’ NI (15,000 – 8,112)  13.8% = £951                 covered by Employment Allowance       (0)
       45,000
 Less  corporation tax @ 20%    (12,000)  (9,000)
 Profits available for dividend    48,000  36,000

nil/10,948/12,615 @ 32.5%                                                                                                3,558

13,403                 6,736

 Less  tax credits nil/42,733/40,000 @ 10%               (4,273)  (4,000)
   13,403    2,463   3,718
 National insurance      
 Class 2 52  £2.80 146    
 Class 4 (60,000 – 42,385)  2% + (42,385 – 8,060)  9%    3,442    
     3,588    
 Class 1 employees (15,000 – 8,060)  12%           833
       
 Net cash received      
 Profit/Salary  60,000    15,000
 Net dividend    48,000  36,000
 Less  income tax  (13,403)  (2,463)  (3,718)
 Less  national insurance   (3,588)                  (833)
   43,009  45,537  46,449

From this it can be seen that Norma’s net receipt is greatest if she operates as a company and draws a £15,000 salary and the balance as dividend. The net inflow is only marginally lower if she draws all the profits as a dividend. Drawing a salary also ensures that her national insurance record is up to date and would enable her to pay pension contributions in excess of the £3,600 limit available to all individuals.

It should also be noted that corporation tax is payable 9 months and one day after the year end, PAYE and class 1 NI are payable monthly during the tax year, and any income tax not collected through PAYE and Class 4 NI is payable by instalments on 31 January in and 31 July following the tax year, and any balance on the following 31 January, along with the Class 2 NI liability.

26 Clarke Ltd

Tutorial note. This question concerns the purchase of a company’s own shares. The choice of dates should have alerted you to the likelihood of the conditions not being satisfied on one of the disposals.

Since Clarke Ltd is an unquoted trading company the capital treatment will automatically apply if the conditions are satisfied. Alex is selling all of his shares, so the reduction to 75% or less of his interest is clearly satisfied. The buying out of a dissident shareholder/director is generally accepted by HMRC as being for the benefit of the company’s trade. The shares subscribed for in 1999 have been held for more than the requisite five years, whereas the shares purchased in May 2011 will only qualify if the repurchase is delayed until June 2016. Entrepreneurs’ relief does not apply because Alex holds less than 5% of the ordinary shares in the company.

May 2011 acquisition – distribution treatment.  
   £
Distribution – excess of proceeds over subscription 2,000  £(5 – 1)   8,000
Additional rate tax £8,000  100/90  (37.5 – 10)%   2,444
Capital gain  
Proceeds not treated as distribution 2,000  £1  2,000
Less cost 2,000  £3  (6,000)
Capital loss  (4,000)

Disposal March 2016

January 1999 acquisition – capital treatment.  
   £
Capital gain  
Proceeds 5,000  £5  25,000
Less cost 5,000  £1  (5,000)
   20,000

Less capital loss on May 2011 shares (above)                                                                                           )

Gain

CGT payable @ 28%

Total tax liability £2,444 + £4,480 = £6,924.

Disposal June 2016

May 2011 acquisition – capital treatment.

  4,480
   £
Capital gain  
Proceeds 2,000  £5  10,000
Less cost 2,000  £3  (6,000)
Gain

January 1999 acquisition – capital treatment.

 4,000
   £
Capital gain  
Proceeds 5,000  £5  25,000

Less cost 5,000  £1 ) Gain

Total gains £(4,000 + 20,000) = £24,000.

CGT liability £24,000  28% = £6,720.

Delaying the disposal until June 2016 enables the capital treatment to apply to the total shareholding and saves tax of £6,924 – £6,720 = £204. More significantly, it also delays the due date for payment of the tax by one year.

27 Daley plc

Tutorial note. Your discussion of loss relief is required to take the form of a letter to the directors, and you should ensure that you give a full and clear explanation.

(a)      Taxable total profits

                                     Year ended         Year ended         6 months      Year ended

ended

                                       31.12.13             31.12.14             30.6.15             30.6.16

£                          £                        £                        £

Trading profits                                                      –                110,000              85,000                        –

Less carry forward loss relief                              –                    (1,000)                      –                         –

  • 109,000  85,000 –

Interest income                                           10,000                  11,000              12,000               14,000

Chargeable gains                                         18,000                           –                       –                         –

(losses are carried forward)                                –                                                                                   

Total profits                                                 28,000                120,000              97,000               14,000

Less current period loss relief                  (28,000)                          –                        –             (14,000)

  • 120,000  97,000 –

Less carryback loss relief                                     –                  (60,000)           (97,000)                       –

  • 60,000 – –

Less qualifying charitable donation                    –                    (2,000)                      –                         –

Taxable total profits                                             –                   58,000                       –                         –

CT @ 20%                                                             –                   11,600                       –                         –

Unrelieved qualifying charitable                     –             –        3,000     1,000 donation

 

Loss memorandum – trading losses                                £                                                                £

Loss                                                                                29,000                                                 202,000

Less current period loss relief                                     (28,000)                                                (14,000)

Less carry back loss relief (6 months)                                                                                      (97,000)

Less carry back loss relief

6/12  £120,000 (restricted)                                                                                                  (60,000)

Loss carried forward                                                       1,000                                                    31,000

A trading loss of £31,000 is available at 30 June 2016 to carry forward against future profits of the same trade.

Loss memorandum – capital losses                                                                                  £

Loss y/e 31.12.14                                                                                                             5,000

Less used in p/e 30.6.15                                                                                                 (2,000)

3,000

Loss y/e 30.6.16       1,000 Loss carried forward at 30.6.16            4,000

(b)                                                                                                                                                     My address

The directors of Daley plc

Their address

Date

Dear Directors

Relief for losses

I am writing to set out for you how Daley plc can obtain relief for losses that it has incurred during its first few years of trading. The company has incurred two different types of losses, capital losses and trading losses.

Capital losses

Capital losses incurred must first be set against any capital gains made in the same accounting period. Any capital losses which cannot be so offset are carried forward and set against capital gains in future accounting periods, as soon as they arise. The offset is automatic, and cannot be disapplied. Capital losses cannot be carried back.

Daley plc incurred a net capital loss of £5,000 in the year ended 31 December 2014. This cannot be carried back against the chargeable gains of £18,000 arising in the year to 31 December 2013 but is carried forward. £2,000 must be offset against the chargeable gains arising in the 6 months to 30 June 2015, leaving £3,000 of unrelieved capital losses to carry forward. Further capital losses of £1,000 arise in the year to 30 June 2016, and these are added to the £3,000 brought forward, so that capital losses of £4,000 are carried forward at 30 June 2016.

Trading losses

Trading losses can be relieved in several different ways, and there are strict rules about how the reliefs interact.

  • A claim can be made for trading losses to be relieved by set off against other profits of the same accounting period. Other profits includes interest income, property income, miscellaneous income and chargeable gains. The trading loss is, however, set off against total profits which is calculated before qualifying charitable donations are deducted, so that if the trading loss exceeds the other income, the qualifying charitable donation is unrelieved.

If the claim is made, the amount of trading loss that is set off is the lower of the company’s other income or the trading loss. It is not possible to restrict the claim, for example to prevent qualifying charitable donations from being unrelieved.

  • If a claim has been made under (i) but not all of the trading loss has been relieved, then a claim may be made for the unrelieved amount to be carried back against the company’s other income of the previous twelve months. Other income is as above, before the deduction of qualifying charitable donations.

Again, the amount of trading loss that is set off is the lower of the company’s other income or the trading loss, and the claim cannot be restricted.

As Daley plc’s previous accounting periods are not all twelve months long, the loss will be carried back against the other profits of the previous accounting period, then against the relevant proportion of the other income of the accounting period before that. Thus because there is an accounting period which is six months long immediately before the loss making period, any loss carried back is set against the profits of the six month accounting period, then against 6/12ths of the profits of the twelve month accounting period before that. When apportioning the profits it is acceptable to apportion the profits before deducting qualifying charitable donations and then to deduct the qualifying charitable donations from the profits which fall outside the twelve month carry back period.

  • Any trading loss which has not been relieved by a claim under (i) or (ii) is carried forward and set off against future profits from the same trade. The set off is automatic, is made against the first available profits, and is equal to the lower of the available loss and the available profits. It is not possible to restrict the amount of loss offset.

Best use of loss

There are two factors which need to be considered when making a loss relief claim. The first is to relieve the loss as soon as possible and the second is to avoid making qualifying charitable donations unrelieved.

Loss of year ended 31 December 2013

A claim was made for this loss to be set against other income of the same accounting period and the balance was carried forward against the loss of the year to 31 December 2014. This meant that £29,000 was relieved at the rate of 20%.

Loss of the year to 30 June 2016

It is proposed that a claim should be made for the loss of the year to 30 June 2016 to be relieved against current and prior year profits. This will result in relief of £40,400 being obtained as follows:

Y/e 30.6.16       £14,000  20% = £2,800, and qualifying charitable donation of £1,000 is wasted

6m/e 30.6.15      £97,000  20% = £19,400, and qualifying charitable donation of £3,000 is wasted

y/e 31.12.14           £60,000  20% = £12,000 y/e 30.6.17              £31,000  20% = £6,200

Alternatively, if the whole loss of £202,000 is carried forward the relief obtained will also be £40,400:

y/e 30.6.17              £150,000  20% = £30,000 y/e 30.6.18              £52,000  20% = £10,400

But, in addition, relief will be obtained of qualifying charitable donations of £4,000 that would otherwise have been wasted, ie a further £800 (£4,000 @ 20%), giving total relief of £41,200.

However, it must be borne in mind that the relief will be delayed compared to a current year and carry back claim.

If I can provide any further information please do not hesitate to contact me. Yours sincerely Certified Accountant

28 Huis Ltd

Tutorial note. The tax consequences of close company status are designed to ensure that people do not use this type of company as a means of avoiding tax.

(a)        The loan to Sartre will lead to Huis Ltd being required to make a payment of £45,000  25% = £11,250 to HMRC. This amount is payable at the same time as the corporation tax for the accounting period, so it is payable by 1 September 2016. (Note that if Huis Ltd were a ‘large’ company the tax on the loan would be subject to the quarterly instalment regime.)

When the loan is written off on 31 March 2017 the company will be entitled to a refund of 25% of the amount waived (ie £45,000  25% = £11,250 refund). This refund will be due nine months and one day after the end of the accounting period of the write off, ie it will be due on 1 September 2018.

Sartre will be deemed to receive income of £45,000  100/90 = £50,000 in the year in which the loan is written off, 2016/17. There will be no further basic rate liability, but for the income falling above the higher rate or additional rate thresholds, tax at 32.5% or 37.5% (but subject to the deduction of the 10% tax credit) will be payable by 31 January 2018. That is, Sartre will be taxed just as if he had received a net dividend of £45,000.

The provision of private medical cover and the use of the yacht are provisions of benefits to a shareholder who is not an employee. Each year they will be treated as net distributions of £(1,000 + 24,000  1/12) = £3,000. This is equivalent to gross income of £3,000  100/90 = £3,333. No further tax will be payable if Sartre is a basic rate tax payer (which will not be the case in 2016/17 due to the loan write off). If he is a higher rate taxpayer he will have a higher rate tax liability of £3,333  (32.5 – 10)% = £750 and if he is an additional rate taxpayer an additional rate tax liability of £3,333  (37.5 – 10)% = £917, payable by 31 January following the end of the tax year through self-assessment.

Huis Ltd will not be able to deduct the medical insurance premium nor the running costs of the yacht for that month in its corporation tax computation.

(b) Beauvoir Ltd – corporation tax liabilities    
    Year ended Year ended
    31.3.15 31.3.16
    £ £
  Property income 14,000 25,000
  Interest income  20,000  100,000
    34,000 125,000
  Less management expenses – current (34,000) (45,000)
                                                 – brought forward (note)                (2,000)
  Taxable total profits           –   78,000

Note. £2,000 carried forward from ye 31.3.15

              Corporation tax at 20%

29 H Ltd, S Ltd and N Ltd

£15,600
Tutorial note. Group relief is only available for corresponding accounting periods.  
  • H Ltd: corporation tax computations for the accounting periods of 12 months to
                                                                                                                             30.6.15 30.6.16
                                                                                                                                   £ £
Trading profit                                                                                                        2,000   –
Less loss carried back                                                                                          (2,000)   –
Taxable trading profits                                                                                                 –   –
Corporation tax payable                                                                                            £–

S Ltd: corporation tax computations for the accounting periods of 12 months to

 £–
                                                                                                                             30.6.15 30.6.16
                                                                                                                                   £ £
Trading profits                                                                                                     30,000 100,000
Less qualifying charitable donations                                                                (12,000)  (12,000)
Taxable trading profits                                                                                       18,000   88,000
Corporation tax  
£18,000  20%                                                                                                                                                                                                          3,600  
£88,000  20%                                                                                                                  17,600
Corporation tax payable                                                                                       3,600  17,600

 

  • Ltd: corporation tax computations for the accounting periods of 12 months and 6 months to
    31.12.15 30.6.16
    £ £
Adjusted profit split 12:6   43,500 21,750
Less capital allowances     (4,250)  (17,569)
Trading profits   39,250 4,181
Interest income              –   20,000
Total profits   39,250 24,181
Less group relief surrendered by H Ltd (W1)    (19,625)  (24,000)
Taxable total profits

Corporation tax

    19,625        181
    £ £
£19,625  20%    3,925  
£181  20%      36

Working

  £
Loss of H Ltd y/e 30.6.16 available for group relief 48,000
Surrendered to N Ltd  
6 months to 31.12.15 lower of (6/12  £48,000) or (6/12  £39,250) (19,625)
6 months to 30.6.16 lower of (6/12  £48,000) or £24,181  (24,000)
   4,375
Loss of H Ltd carried back    (2,000)
Loss of H Ltd carried forward     2,375

Group relief / loss relief

Group relief is not available for S Ltd because it is only a 60% subsidiary.

  • To:            The Directors of H Ltd From:            Certified Accountant

Date:        31 December 2016

Re:          Minimisation of corporation tax on property transactions

H Ltd and N Ltd are in a chargeable gains group because H Ltd holds 100% of the shares in N Ltd. S Ltd is not part of a group with H Ltd because H Ltd only has a 60% shareholding (75% required for a capital gains group)

There are several factors which will affect the corporation tax liability on the proposed disposals.

  • The loss of £26,667 made by N Ltd in November 2014 is a pre-entry loss and so cannot be offset against gains on the disposals by H Ltd.
  • Rollover relief is available against the purchase of the new warehouse. As the cost is only £290,000, only £60,000 of the gain on the old warehouse can be rolled over into the purchase of the new warehouse acquired by S Ltd. The balance of £10,000 cannot be rolled over, as there are surplus proceeds of £10,000 and S Ltd is not in a group with H Ltd and N Ltd so cannot benefit from group rollover relief.
  • The gain of H Ltd of £80,000 and the post-entry loss of N Ltd of £13,333 should be matched by electing that N Ltd transfer the loss to H Ltd.

The net position for H Ltd is then:

£

Sale of factory          (13,333)  Sale of office block            80,000

Total gains                                                                                                                                  66,667

Corporation tax £66,667  20%                                                                                                13,333

S Ltd will have a gain of £10,000 taxed at 20%, giving corporation tax of £2,000.

  • Ltd will have a pre-entry loss of £26,667 carried forward.

Signed: Certified Accountant

 

30 Exotica Inc and W Ltd

Tutorial note. In part (b) you were asked to produce a report so it is important that you did so. Marks may be specifically allocated for report writing or letter writing skills.

  • If the salesmen have authority to conclude contracts, there will almost certainly be a permanent establishment in the United Kingdom, and its profits would therefore be liable to UK corporation tax. The holding of stocks would not, however, by itself show that there was a permanent establishment.

Taxable profits would be determined as if the permanent establishment had an arm’s length relationship with the company, so that tax liabilities could not be manipulated by transfer pricing.

  • REPORT

To:                  The Board of Directors

From:             Certified Accountant                                                         Date: 1 November 2015

Subject:         Taxation implications of the overseas operation

  • UK taxation arises on the profits of an overseas permanent establishment (PE), and any losses of such a PE will, provided that the PE is controlled in the UK, be aggregated with the profits or losses of the UK division. It is possible to make an election so that the profits of the overseas PE are exempt from UK corporation tax. However, this means that no relief would be available if the PE were to make a loss.  The election is irrevocable and applies to all permanent establishments, so may not be appropriate if you anticipate that you may set up further PEs in the future that may initially be loss-making.

There will normally be no UK taxation on dividends paid by an overseas subsidiary to a UK company. Losses of an overseas subsidiary cannot be relieved against the UK company’s profits, as group relief is only available between UK resident companies and between UK and EU resident companies in certain restricted circumstances.

  • Foreign tax will arise on the profits of both PEs and subsidiaries. To the extent that the profits of the PE suffer both foreign and UK taxation, double taxation relief will be available, either under a treaty or under the UK’s unilateral relief provisions. The usual effect is that the overall tax rate is the higher of the UK rate and the foreign rate. Since any dividends paid by a subsidiary will not normally be subject to UK tax, double taxation relief will not be relevant.
  • Assets cannot be transferred outside the scope of UK taxation to a foreign subsidiary on a no gain/no loss basis, so capital gains may arise. However, any such gains may be deferred until shares in the subsidiary are sold. If assets are transferred to a PE, there is no change of ownership so CGT is not triggered.
  • A subsidiary will only be treated as not UK resident if it is not incorporated in the UK and its central management and control are abroad.

Signed: Certified Accountant

31 Paul

Tutorial note. These rules are really designed to stop people avoiding VAT by establishing several different businesses with a turnover below the registration threshold.

VAT law recognises a ‘taxable person’ rather than a business. All business activities of the same person are regarded as a single VATable activity, and are brought within the same registration if the person is, or is required to be, registered. The same individual is a single ‘person’ for all activities carried on in his own capacity; and two partnership activities are also a single person, if exactly the same people are partners in both firms.

Conversely, related business activities may be regarded separately under VAT law if they are carried out by different ‘persons’. Examples of different persons would be:

  • Individuals
  • Partnerships with different partners
  • Different limited companies

HMRC may question whether there really is a separation of activities between different persons. If the activities are in reality carried on by someone else, they will form part of that person’s taxable turnover, even if that person argues that the supplies are made by another.

In this situation, there are four possible taxable persons:

  • Paul trading alone (as a sole trader)
  • Paul and John
  • Paul and Peter
  • Paul and Jane

HMRC may question the reality of any of the partnerships. They will consider whether the parties involved are closely bound by financial, economic and organisational links.

For example HMRC may consider whether there is:

  • A proper written partnership agreement
  • Evidence of the parties’ intentions
  • Actual sharing of profits (not just income or expenses)
  • Notification of customers, suppliers and other authorities (eg on stationery)
  • Authority of partners to bind the firm  Ownership of common assets

They may also consider how the business is treated for direct tax purposes.

If they consider any of the partnerships to be artificial, the activities of that partnership will be treated as carried on in conjunction with the sole trade.

Conversely HMRC may also issue a business splitting direction.

32 VAT groups

Tutorial note. Marks may be specifically allocated for letter writing skills. Would you have gained them here?

Our address

Your address

Date

Dear Mr Franklin

Group registration

I am writing in reply to your recent enquiry regarding Union Ltd, specifically the question of whether that company should be included in the group VAT registration and the procedure for so doing.

First, I confirm that group registration is possible, since all the companies are either established or have a fixed establishment in the UK and they are all under common control.

It would be advisable for Union Ltd to be included in the group registration, for two reasons:

  • To avoid the need to account for VAT on intra group transactions and hence minimise the risk of VAT being underdeclared in error. For example, the group relief payments to which you refer in your letter would not normally constitute consideration for taxable supplies and so would not give rise to the need to account for VAT, even between companies which are not in a group registration. However, in certain circumstances HMRC might argue that the ‘group relief payments’ in fact amount to consideration for a taxable supply, giving rise to an output tax liability; for example, if the payments were linked to services provided by Union Ltd to other group companies.

By including Union Ltd in the group registration, such potential problems are avoided.

  • As Union Ltd is partly exempt, around 40% of any input tax it incurs is irrecoverable. If Union Ltd is not included in the group registration, any standard-rated supplies which it receives from other group companies would generate additional irrecoverable VAT.

It is also necessary to consider, however, the effect of including a partly exempt company in the group registration. This will depend in part on the partial exemption method used by Union Ltd at present and the method to be used by the group if Union Ltd is included. Under the standard method, more of Union Ltd’s overhead input tax would become recoverable but some of the group’s would be lost.

It should however be borne in mind that the partial exemption de minimis limit will apply to the group as a whole and is not multiplied by the number of companies in the group registration.

So far as the procedure is concerned, an application needs to be made to HMRC for Union Ltd to be added to the group registration. All applications to join an existing VAT group will automatically be approved by HMRC and will take effect from the date they are received by HMRC (or such earlier or later time as HMRC may allow). HMRC will not normally permit retrospective grouping, so Union Ltd will have to be accounted for separately until you make the application.

HMRC do have the power to refuse an application within 90 days of its receipt if the application does not meet all of the eligibility criteria (which should not be a problem in your case) or presents a risk to the revenue. It is not thought that a slight improvement in the partial exemption position would be sufficient to warrant a refusal on the grounds of risk to the revenue; the improvement would have to go beyond the simple effects of grouping, so something ‘artificial’ would have to be involved.

Please do not hesitate to contact me if I can be of further assistance.

Yours sincerely

Certified Accountant

 

33 Stewart Ltd

Tutorial note. Remember to round up the percentage recovery to the nearest whole number.

  • Residual input tax

6/15                 9/15                12/15                3/16                Total

£                       £                       £                       £                       £

‘T’ (note 1) 403,920 359,177 467,159 520,321 1,750,577 ‘T + E’ 455,992 382,371 485,950      557,760 1,882,073

T/T + E (note 2)                   89%                  94%                  97%                  94%                  94%

Residual tax                       14,719               12,613             10,412              11,919             49,663

Notes

  • Excludes sale of capital asset used in the business.
  • Rounded up to nearest whole percentage point.
  • Exempt input tax

6/15                 9/15                12/15                3/16                Total

£                       £                       £                       £                       £

Direct                                  3,120                2,775                1,374                1,876               9,145

Share of residual                                             757                   312                   715               2,980

3,532                1,686                2,591             12,125

De minimis test 3? N            N            Y             N            N (note)

Note. Less than £625 pm and less than 50% of the total

  • Recoverable input tax

6/15                 9/15                12/15               3/16                 Total

£                       £                       £                      £                       £

Direct                                 44,404              39,098             24,926             36,020            144,448

Exempt de min.                          –                       –               1,686                      –                        –

Share of residual                                                                                                                   46,683

Total recovered in the four quarterly returns:  192,394
Annual adjustment – due to HMRC   (1,263)

191,131

The annual adjustment will be made by reducing the input tax for the return period to June 2016.

34 Tax planning

Tutorial note. In this question it was important to allocate your time carefully between each of the queries raised.
  • Incorporation should take place when the business starts to make profits, on 1 May 2017.

Advantage can then be taken of early trade loss relief, which is only available to unincorporated businesses. This relief is against income of the three tax years preceding the year of loss, taking earlier years first. Relief will be obtained against the salary of the last few years before Client A became self-employed, leading to repayments of tax.

  • B’s current annual profit is £60,000  40% = £24,000.

With the contract, B’s turnover will be over the registration limit so he will have to register for VAT. He will be able to charge VAT on top of the contract price, as the customer is registered and will be able to reclaim the VAT. However, as the business is highly competitive he will have to absorb the VAT which he will have to charge to other customers, and not increase his prices. This will be offset to some extent by the fact that he will be able to reclaim VAT suffered on his purchases.

Thus his overall profit margin on normal sales will be reduced to 40%  100/120. The new annual
profit will be as follows.    
  £ £
Normal sales    60,000
Less VAT on normal sales  1/6    (10,000)
     50,000
Less normal purchases £60,000  60%  36,000  
  Less VAT on normal purchases  1/6   (6,000)  
     (30,000)
Profit on normal sales     20,000
Contract sales  25,000  
Less cost of contract sales £25,000  60%  (15,000)  
       10,000
Revised annual profit    30,000

Therefore annual profit will only increase by £6,000, despite the new contract of value being £25,000.

If B attempted to avoid VAT registration by having a separate company handle the contract, HMRC could aggregate the turnovers of B’s own business and the company’s business, making both B and the company liable to register. The consequence would be that no saving would be achieved.

  • It is in general bad planning to hold an asset likely to rise in value in a company. When the asset is sold, the company will have to pay corporation tax at 20% on the gain. If the proceeds are paid out as a dividend, further tax will be suffered by higher rate taxpayers. If they are paid out in the course of winding up the company, the shareholders will have chargeable gains on their shares.

The scheme has several other flaws. Dividend income is not taxable in the hands of a UK company so there is no question of a deduction for the director’s fees from the company’s taxable income, as it will not have any taxable income. Also, the payment of the fees will have adverse consequences as primary (employee’s) Class 1 NICs will arise (secondary (employer’s) Class 1 NICs would be covered by the employment allowance). Finally, tax relief is only available on pension premiums up to the level of his earnings, not on any dividends he draws out from the company.

  • Sole trader

£

Profits                                                                                                                                         30,000

IT £30,000  20%                                                                                                                       (6,000)

NIC     Class 2 £2.80  52                                                                                                              (146)

Class 4 £(30,000 – 8,060)  9%          (1,975)  Net spendable income       21,879

Company

£

CT £30,000  20%                                                                                                                       6,000

 

Net profits before distribution (£30,000 – £6,000)                                                                 24,000

 

Dividend  100/90                                                                                                                     26,667

Tax @ 10%                                                                                                                                   2,667

Less tax credit                                                                                                                            (2,667)

Income tax                                                                                                                                         nil

 

Net spendable income = net dividend                                                                                      24,000

35 Hulse Finds Ltd

Tutorial note. Although the question may appear long on first reading note how it breaks down into a series of points.

  • The interest paid by Paul on the loan to acquire the shares in the company is qualifying annual interest. This is because Hulse Finds Ltd is a close company (it is controlled by Paul and Nick) and Paul works full-time for the company. Qualifying annual interest is a deductible payment that is deducted from Paul’s total income, and consequently reduces his net income.
  • Hulse Finds Ltd is a close company and has made a loan to a participator, Chris. Accordingly, the company should have paid HM Revenue & Customs (HMRC) £2,500 (25% of the loan) by 1 January 2017 (ie nine months and one day after the end of the accounting period). HMRC will repay the £2,500 when the loan is repaid by Chris or waived by Hulse Finds Ltd. The company would not have had to make any payment if Chris had worked full-time for the company, as the loan is for less than £15,000 and Chris does not own more than 5% of Hulse Finds Ltd.
  • The tax implications arising out of the acquisition are:
    • The capital losses of SNL will remain with SNL. SNL will sell its trade and assets to SN2 Ltd and capital losses remain with a company when it sells its trade. SNL can use its capital losses to relieve any gains arising on the assets sold to SN2 Ltd.
    • The trading losses of SNL will also remain with SNL and will not to be transferred with the trade. Where a company sells its trade to an unconnected company, any trading losses remain with the vendor company. SNL may be able to offset the losses against any capital allowance balancing charges arising on the sale.

It is possible for trading losses to be transferred to the purchaser when a company sells its trade to another company, but only when certain conditions are satisfied. Broadly, the same persons must beneficially own at least 75% of the business both before and after the sale. These conditions would have been satisfied if SNL had formed a subsidiary, Newco, sold its trade to Newco, and then sold Newco to SN2 Ltd.

SNL is the legal and beneficial owner of its trade prior to the sale. If the trade had been sold to Newco, SNL would no longer be the legal owner of the trade but would still be the beneficial owner as it owns Newco.

In such circumstances, Newco could have used the trading losses against future trading profits arising from the same trade, provided there was no major change in the nature or conduct of its trade within three years of the purchase by Hulse Finds Ltd.

  • The tax implications of the Newland business depend on the legal structure used. From a tax point of view, there are two distinct ways of establishing the business:
    • It could be owned directly by Hulse Finds Ltd (or SN2 Ltd). Under this option, it would be an overseas permanent establishment of a UK resident company.
    • Hulse Finds Ltd (or SN2 Ltd) could incorporate a new subsidiary in Newland to acquire the business. Under this option, it would be an overseas subsidiary of a UK resident company.

Overseas permanent establishment

A permanent establishment is not a separate legal entity but is an extension of the company that owns it. The profits or losses of the permanent establishment belong directly to the company.

Provided the permanent establishment is controlled from the UK, the trading loss made in the year ended 31 March 2019 could be offset by Hulse Finds Ltd (or SN2 Ltd) against its income and gains of that year, reducing the company’s UK corporation tax liability. Once the permanent establishment is profitable, the company owning the permanent establishment will be subject to 45% Newland corporation tax on the permanent establishment profits, because it is trading within the boundaries of Newland from permanent establishment.

The profits will also be subject to UK corporation tax because a UK resident company is subject to tax on its worldwide income and gains. However, the UK corporation tax liability, in respect of the permanent establishment profits, will be fully relieved by double tax relief as the rate of corporation tax in Newland is higher than that in the UK. Accordingly, there will be no UK corporation tax to pay on the permanent establishment’s profits.

It is possible to make an election to exempt the profits and losses of an overseas permanent establishment from UK corporation tax.  However, this election would not be appropriate here. The losses in the first year would not be available for relief against Hulse Finds Ltd’s (or SN2 Ltd’s) profits as described above, and it is not necessary to exempt the profits in future years, because, as explained above, double tax relief means there will be no UK corporation tax on these profits anyway.

Overseas subsidiary 

A subsidiary is a separate legal entity. A company incorporated in Newland will be resident in Newland for tax purposes, provided it is not managed and controlled from the UK. Its profits or losses will then be subject to the tax regime of Newland.

The trading loss of the year ended 31 March 2019 would be carried forward and deducted from the company’s future trading profits arising out of the same trade.

Once the company is profitable, it will be subject to tax in Newland at the rate of 45%. No UK tax will be due on the overseas dividends.

Choice of business medium

It is usually suggested that a permanent establishment should be used where an overseas enterprise is expected to make initial losses. This strategy enables the losses to be offset against any other profits of the company. However, the particular facts of the situation must be considered carefully.

The use of a permanent establishment in Newland will enable Hulse Finds Ltd (or SN2 Ltd) to offset the losses against its profits for the year ended 31 March 2019. This will save UK corporation tax at a rate of 20%.

The use of a subsidiary would mean that the losses could not be offset in the year ended 31 March 2019, as the subsidiary will not have any other income. However, in the following year the losses will reduce that year’s profits and save tax in Newland at 45%.

Accordingly, provided the group is willing to wait for a year (from a cash flow point of view) a greater tax saving can be achieved by using a subsidiary in Newland rather than a permanent establishment. This assumes, of course, that the anticipated profits materialise in the year ended 31 March 2020.

36 Financial planning

Tutorial note. The choice between equity and debt finance is a very important consideration when raising additional funds. The implications you discuss must be relevant to the situation outlined. For example, an individual subscribing for shares in a seed enterprise investment company (SEIS) can receive 50% income tax relief on investment up to £100,000 in 2015/16, but M Ltd is unlikely to be a qualifying company, as it is not a small start up.

Report

To:       The Board of M Ltd

From: Certified Accountant

Date: 19 May 2015

Re:     Taxation consequences of alternative methods of raising finance

The choice of raising additional funds to finance a major expansion of the business can be summarised as being between loan capital or equity. A major distinction between the two forms of financing is that interest payable on borrowings is deductible for corporation tax purposes whereas dividends payable to shareholders are not.

Loan capital

Interest is tax deductible on an accruals basis under either from trading profit (if put to a trading use) or from interest income.

If the loan interest being paid represents an annual payment other than to a UK bank or a UK resident company, income tax should be deducted at source and accounted for to HMRC.

Costs of obtaining loan finance will be treated as tax-deductible in the same manner as interest payable on the loan. In contrast, costs in respect of issuing share capital are not deductible for CT purposes.

Interest income received by the providers of loan finance is taxable. It will be interest income of a company and subject to tax at the normal corporation tax rate of 20%. Individuals in receipt of interest income will be subject to tax on the gross amount at 20%, 40% or 45%.

Equity finance

Dividends represent appropriations of profit after tax. They are not tax deductible and any costs associated with the raising of share capital are not tax deductible.

With regard to providers of equity finance, there are tax benefits available to investors who invest in Enterprise Investment Scheme (EIS) shares:

  • An individual subscribing for new ordinary shares in an unquoted trading company can claim income tax relief at 30% for an investment of up to £1,000,000 in a tax year. The individual can also make a claim to carry back an investment to the previous tax year, subject to the maximum for that year. For example, if an individual has not previously made any EIS investment, he can invest £2,000,000 in EIS shares in 2015/16 and treat £1,000,000 as invested in 2014/15 and £1,000,000 in 2015/16.

If the EIS shares are held for three years, there is exemption from capital gains tax on a disposal of the shares. A capital loss may arise on a disposal before or after expiry of the three year period but it is restricted by reducing the issue price by the amount of relief obtained.

  • Chargeable gains realised by individuals may be deferred provided that those gains are reinvested in the ordinary shares of a qualifying EIS unquoted trading company. The reinvestment of gains must be made in the period twelve months before to three years after the relevant disposal. The gain is deferred and does not therefore crystallise before a subsequent disposal of the new EIS shares.

If you wish to discuss further any of the above points do not hesitate to contact me.

Signed: Certified Accountant

37 Daniel

Tutorial note. There are only a very few calculations needed here. You need to write a memo and include the figures at the relevant points. Take care to plan your answer well ensuring you know what headings are needed so you cover all the points.

MEMORANDUM

To:             Tax manager

From:        Tax assistant

Date:         2 June 2016

Subject: Saturn Ltd group of companies

This memorandum considers a number of issues raised by Daniel, the managing director of Saturn Ltd.

(a)        (i)        Dione Ltd – Use and value of tax loss

Any amount of the loss can be surrendered to the UK resident members of the 75% loss group, ie Saturn Ltd and Rhea Ltd.

The best use of the loss will be achieved by surrendering it to Saturn Ltd. Rhea Ltd will make a loss in the year to 30 June 2017 and will be able to set this against its total profits for the year to 30 June 2016.

Surrender to Saturn Ltd is also better than carrying the loss forward as this could take several years for the loss to be relieved, given Dione Ltd is expected to make minimal profits in the year ended 30 June 2017.

The surrender of the loss to Saturn Ltd will save corporation tax at the rate of 20% ie £187,000  20% = £37,400.

Further information required

Income and gains of Dione Ltd for the year ended 30 June 2015.

The loss could be carried back for offset against the total profits of Dione Ltd for the year ended 30 June 2015 which would be a cashflow benefit.

(ii)       Tethys Ltd – Use of trading loss 

The two companies will not be in a group relief group as Saturn Ltd will not own 75% of Tethys Ltd.

For a consortium to exist, 75% of the ordinary share capital of Tethys Ltd must be held by companies which each hold at least 5%. Accordingly, Tethys Ltd will be a consortium company if the balance of its share capital is owned by Clangers Ltd but not if it is owned by Edith Clanger.

If Tethys Ltd qualifies as a consortium company: 65% of its trading losses in the period from 1 August 2016 to 31 December 2016 can be surrendered to Saturn Ltd, ie £21,667 (£80,000  5/12  65%). Saturn Ltd must have taxable profits in excess of this in the period 1 August 2016 to 31 December 2016.

If Tethys Ltd does not qualify as a consortium company, none of its loss can be surrendered to Saturn Ltd.

The acquisition of 65% of Tethys Ltd is a change in ownership of the company. If there is a major change in the nature or conduct of the trade of Tethys Ltd within three years of 1 August 2016, the loss arising prior to that date cannot be carried forward for relief in the future.

Further information required

Ownership of the balance of the share capital of Tethys Ltd.

Estimate of taxable profits of Saturn Ltd for the year ended 30 June 2017.

(iii)      Tethys Ltd – Sale of the manufacturing premises

Value added tax (VAT) 

The building is not a new building (ie it is more than three years old). Accordingly, the sale of the building is an exempt supply and VAT should not be charged unless Tethys Ltd has opted to tax the building in the past.

Taxable profits on sale 

The capital gain arising on the sale of the building will be £97,760 (£240,000 – (£112,000  1.27)).

Rollover relief

Tethys Ltd is not in a capital gains group with Saturn Ltd. Accordingly, rollover relief will only be available if Tethys Ltd, rather than any of the other Saturn Ltd group companies, acquires sufficient qualifying business assets.

The amount of sales proceeds not spent in the qualifying period is chargeable, ie £40,000 (£240,000 – £200,000). The balance of the gain, £57,760 (£97,760 – £40,000), can be rolled over.

Qualifying business assets include land and buildings and fixed plant and machinery. The assets must be brought into immediate use in the company’s trade.

The assets must be acquired in the four-year period beginning one year prior to the sale of the manufacturing premises.

Further information required

Whether or not Tethys Ltd has opted to tax the building in the past for the purposes of VAT.

(iv)      Stamp duty and stamp duty land tax 

The purchase of Tethys Ltd will give rise to a liability to ad valorem stamp duty of £1,175 (£235,000  0.5%). The stamp duty must be paid by Saturn Ltd within 30 days of the share transfer in order to avoid interest being charged. It is not an allowable revenue expense for the purposes of corporation tax.

There are no stamp duty land tax implications for the Saturn Ltd group, unless Tethys Ltd acquires land and buildings (see part (iii)).

(b)       Before agreeing to become tax advisers to the Saturn Ltd group

Information needed

Proof of incorporation and primary business address and registered office.

The structure, directors and shareholders of the company.

The identities of those persons instructing the firm on behalf of the company and those persons that are authorised to do so.

Action to take

Consider whether becoming tax advisers to the Saturn Ltd group would create any threats to compliance with the fundamental principles of professional ethics, for example integrity and professional competence. Where such threats exist, we should not accept the appointment unless the threats can be reduced to an acceptable level via the implementation of safeguards

Contact the existing tax adviser in order to ensure that there has been no action by the Saturn Ltd group that would, on ethical grounds, preclude us from accepting appointment.

38 Stuart and Rebecca

Tutorial note. Read the question requirements carefully. Part 2, for example, asks you to consider two alternatives. There are no marks available for doing anything else.

PRIVATE AND CONFIDENTIAL

[Our address]

[Your address]

[Date]

Dear Stuart

TAX POSITION AND ESTATE PLANNING

This letter deals with the capital gains implications of your recent property sale and your current and potential inheritance tax liabilities.

  • Capital gains on property disposal 2016/17

The capital gain arising on the disposal of the Plymouth house is £15,532.

This is after taking account of principal private residence relief of £141,318, based on an exempt period of 90 months out of a total ownership period of 151 months, and letting relief of £40,000.

The calculation of the above figures can be found in Appendix 1.

  • Proposed investment

As you are considering making an investment in a quoted company you will only be able to obtain business property relief for inheritance tax purposes if you, together with Rebecca, control the company, ie over 50% of the shares.

You could buy approximately 1 million shares in Omikron plc. This would be in the region of a 2% holding, so no business property relief would be available.

Alternatively you could buy approximately 195,000 shares in Omega plc with the proceeds, at a cost of 216p. Currently you and Rebecca jointly hold 4.8 million shares. Provided you achieve a slightly lower price or invest slightly more so that you purchase 200,001 shares, you and Rebecca will have a controlling holding. Provided you then survive for at least two years you will achieve 50% business property relief on your Omega plc shares.  Therefore, it would be preferable to invest in future Omega plc shares.

  • Inheritance tax on Rebecca’s estate 1 March 2019

Upon your death, the transfer of your assets to Rebecca would be exempt from IHT. If, following your death, Rebecca were to die on 1 March 2019, and no IHT planning is implemented, the IHT liability would be £2,512,420 (Appendix 2).

  • Lifetime IHT planning

As your will leaves all of your estate to Rebecca you have not taken advantage of your nil rate band. However on Rebecca’s death her nil rate band will be increased by the proportion of nil rate band unused at your death. She will therefore have an additional 100% of your nil rate band available on her death. This will be based on the value of the nil rate band at that time.

The Omega plc shares should be left to Rebecca so that the 50% BPR would be available on her death or earlier gift of the whole shareholding.

Rebecca should consider making lifetime gifts, perhaps to Sam, in the hope that she will survive for seven years, so that they become completely exempt. If she survived more than three but less than seven years, and IHT was payable on the lifetime gifts, then the IHT payable would be tapered.

Both of you should make lifetime gifts utilising your annual exemptions. Each of you would have a current year and a prior year annual exemption available, as you have made no earlier gifts. You may also be able to establish a regular pattern of giving to use the exemption for normal expenditure out of income. Your wealth would appear to be such that it would be simple to demonstrate that capital was not being eroded by this strategy, and that you can maintain your usual standard of living.

It could be possible to give away the life policy before death at a lower value than the death benefit. It would then be excluded from the death estate and escape any IHT liability.

If you wish to discuss further any of the above points do not hesitate to contact me.

Yours sincerely

Certified Accountant

Appendix 1 – disposal of Plymouth property

   £
 Sale proceeds 422,100

Less cost May 2004                                                                                                                                          )

 

Less PPR exemption        £237,100 (W)                                                                            (141,318)

  95,782
 Less letting exemption, lowest of:  
 (i)     PPR relief given: £141,318  

(ii)     Gain in let period:   £237,100 = £42,395                                                                                 

 (iii) Maximum: £40,000     (40,000)
 Gain   55,782
 Less capital losses brought forward     (29,150)
      26,632
 Less annual exempt amount       (11,100)
 Taxable gain

Working

       15,532
     Exempt  Non-exempt
 Periods of occupation    Months  Months
 1 May 2004 – 31 Aug 2006 Occupied  28  
 1 Sept 2006 – 30 June 2010 Unoccupied – absence for any reason  36  
  Unoccupied    10
 1 July 2010 – 30 Sept 2012 Let    27
 1 Oct 2012 – 31 May 2013 Occupied    8  
 1 June 2013 – 31 May 2015 Unoccupied    24

1 June 2015 – 30 Nov 2016       Last 18 months                                                                                        

61

Appendix 2 – Rebecca’s IHT liability with no IHT planning    
   £  £
London property    900,000
Cash deposits (including £200,000 from life policy)    530,000
Quoted investments    250,000
Shares in Omega plc 5,001,000  210p (1/4 up is lower)  10,502,100  
Less BPR @ 50%   (5,251,050)  
Less nil rate band (£325,000 + 100%  £325,000)      (650,000)
Taxable at 40%    6,281,050
IHT liability    2,512,420

39 Landscape Ltd

Tutorial note. Make sure you make an attempt at each part of the question and do not spend too long on any one part.

  • Peter Plain

The distinction between employment and self employment is a fine one. Employment involves a contract of service, whereas self employment involves a contract for services. Taxpayers tend to prefer self employment because the rules for the deductibility of expenses are more generous but the following factors suggest that HMRC will regard Peter as an employee rather than self employed:

  • Peter works five days each week: If Peter cannot work when he chooses it suggests the company has control over him and he is an employee
  • Peter uses the company’s equipment
  • Peter does not have any other clients
  • The computer function (and hence Peter) is an integral part of the company’s business.

Other factors HMRC may consider are:

  • whether Peter must accept further work
  • whether the company must provide further work
  • whether Peter hires his own helpers
  • what degree of financial risk Peter takes
  • what degree of responsibility for investment and management Peter has
  • whether Peter can profit from sound management
  • the wording used in any agreement between Peter and the company.
  • Simon Savannah

The statutory redundancy pay of £2,400 is exempt from income tax. However, both the holiday pay of £1,500 and the £5,000 in respect of the agreement not to work for a rival company are taxable in 2015/16.

The balance of the lump sum redundancy payment is £46,100 (£55,000 – £2,400 – £1,500 – £5,000). If the payment is a genuine ex gratia redundancy payment, £27,600 (£30,000 – £2,400) is exempt. £8,500 is taxable in 2015/16. The balance of £10,000 is taxable when received in 2016/17.

  • Trevor Tundra

Landscape Ltd is a close company and Trevor Tundra is a participator. This means that Trevor will be treated as though he has received dividends equal to the earnings that would have arisen in

2015/16 if he had been a director or an employee of Landscape Ltd.

£

Car (£14,000  35%) (W)                                                                                                          4,900

Loan (£40,000  2/12  3%) + (£15,000  7/12  3%)                                                             462

Loan written off            15,000  Taxable benefits = net dividend        20,362

Working

CO2 emissions = 200 g/km

Above baseline figure 200 – 95 = 105g/km

Divide by 5 = 21

% = 14 + 21 = 35%

(d)       Ursula, Violet and Wilma

Ursula, Violet and Wilma are all working in Cambridge in the performance of their duties. Tax relief is available for the cost of travel between home and Cambridge, if Cambridge is a ‘temporary’ place of work. A place of work is classed as a temporary workplace if the employee does not work there continuously for a period which lasts (or is expected to last) more than 24 months.

Therefore, the cost of all of Ursula’s travel to Cambridge qualifies for tax relief. The mileage allowance that Ursula receives from the company falls within the authorised mileage rates and so is tax free and she can make an expense claim as follows:

Authorised mileage rates                                                                                                               £

(120  40) = 4,800  45p                                                                                                          2,160

Less mileage allowance received (4,800  41p)                                                                     (1,968)

Expense claim                                                                                                                                192

As Violet was initially expected to work in Cambridge for more than 24 months the train fare initially paid by Landscape Ltd is a taxable benefit. However, from 1 January 2016 no taxable benefit arises in respect of the train fare because Violet’s period of secondment to Cambridge is no longer expected to exceed 24 months.

Wilma should be entitled to full tax relief for the cost of her journey’s to Cambridge. Wilma will be assessed on a benefit as follows:

£

Mileage allowance received (120  150) = 18,000  41p                                                        7,380

Less authorised mileage rates 10,000  45p                                                                           (4,500)

8,000  25p         (2,000) Taxable benefit          880

(e)       Landscape Ltd can give an employee up to £3,600 worth of ‘free’ shares a year. Employees can buy ‘partnership’ shares with their pre-tax salary up to a maximum of 10% of gross earnings, subject to an upper limit of £1,800 per year.

In addition, employers can give employees up to two free matching shares for each partnership share purchased. Provided the shares are held for five years before disposal, employees will not be subject to income tax or NIC on them. If the shares are held for more than three years but less than five years, tax and NIC is due on the lower of the market value of the shares on the date they were given to the employee and the market value at the date of withdrawal.

40 Marilyn

Tutorial note. In part (a) it was essential to recognise that the spouse exemption applied to the result bulk of Max’s estate. Part (b) concerned the rules on transfer of unused nil band between spouses on the death of the survivor. Make sure you learn this topic.

(a)      Inheritance tax liability on the death of Max 20 May 2014

All of Max’s estate (except the chattels) passes to Marilyn for IHT purposes. Therefore the spouse exemption applies to these assets.

The chattels passing to Max’s brother total £15,000 (£5,000 + £7,000 + £3,000) and are covered by the nil rate band.

Therefore, there is no IHT payable on the death of Max.

Inheritance tax liability on death of Marilyn February 2016

 Free estate    
                 Personalty  £  £
                 Berkley’s Bank a/c  33,400  
                 Unit trust units in ISAs  72,000  
                  Cash ISA  10,600  
                  Ex-cash ISA from Max  11,300  
                 Bank deposit a/c from Max  20,000  
                  Spiro plc (W)  63,600  
                 Unit trusts  81,000  
                 Unit trusts – ISAs   67,600  
  359,500  
                 Realty    
                 Family home (whole)  220,000  
                 Holiday home   73,000  293,000
     
 Gross estate

 

   652,500
Tax is:   £
£325,000  0%   Nil
£327,500  40%    131,000
     131,000

Working

Valuation of Spiro plc shares at February 2016 is lower of:

¼ up

635638

Mid-bargain

636

ie 636  10,000 =  £63,600

(b)       A claim can be made to transfer Max’s unused nil rate band to increase the maximum nil rate band available on the death of Marilyn. The claim will usually be made by the personal representatives of Marilyn’s estate within two years following the end of the month of Marilyn’s death (ie by 28 February 2018).

Max’s unused nil rate band is £(325,000 – 15,000) = £310,000. Since the nil rate bands are the same in 2014/15 and 2015/16, this is also the amount available to transfer to Marilyn.

The nil rate band available to set against Marilyn’s estate is therefore £(325,000 + 310,000) = £635,000.

£
The IHT on her estate is therefore:

£635,000  0%               0 £17,500  40%                   7,000

    7,000

The inheritance tax saving is £(131,000 – 7,000)             124,000  (which is 40% of £310,000)

(c)        Since Max owned ISA investments at his death, Marilyn, as his spouse, is entitled to an additional ISA allowance equal to the value of the ISA investments held by Max at his death (ie £59,800).

 

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