ACCA Paper P6 Advanced Taxation Dec-2013 To gain maximum benefit, do not refer to these answers until you have completed the interim assessment questions and submitted them for marking.
ACCA P6 (UK): ADVANCED TAXATION Kaplan Financial Limited, 2013 The text in this material and any others made available by any Kaplan Group company does not amount to advice on a particular matter and should not be taken as such. No reliance should be placed on the content as the basis for any investment or other decision or in connection with any advice given to third parties. Please consult your appropriate professional adviser as necessary. Kaplan Publishing Limited and all other Kaplan group companies expressly disclaim all liability to any person in respect of any losses or other claims, whether direct, indirect, incidental, and consequential or otherwise arising in relation to the use of such materials. All rights reserved. No part of this examination may be reproduced or transmitted in any form or by any means, electronic or mechanical, including photocopying, recording, or by any information storage and retrieval system, without prior permission from Kaplan Publishing. 2 KAPLAN PUBLISHING
1 PHIL MITCHEL Key answer tips The format of this question is similar to the style adopted by the P6 examiner, and it is important to become comfortable with seeking out the information needed as well as the detailed requirements, which may be buried in the question. Here you are asked to respond to an email from your manager, providing notes for her to take to a client meeting. It is therefore not necessary to adopt a formal letter style, and you can assume your manager understands basic tax terms, but it is important to lay out your answer clearly, with appropriate headings and clearly referenced workings. This is a classic capital taxes question, covering IHT and CGT in detail. It is a common exam scenario to have to deal with both the IHT and CGT implications of lifetime gifts, and it is important that you are comfortable with dealing with both taxes in the same scenario, and that you recognise where different valuation rules and exemptions or reliefs will apply. Part (a) is a straightforward inheritance tax question involving a number of lifetime gifts which become chargeable on death and then the tax on the death estate. Part (b) is a capital gains calculation involving Entrepreneurs relief and gift relief. Part (c) covers the commonly tested topic of deeds of variation. To: From: Martina Smith Tax assistant Date: 13 June 2013 Subject: (a) Notes for meeting Phil Mitchel (deceased) Inheritance tax implications of Phil s death Key answer tips This part is a straightforward inheritance tax calculation which includes a number of regularly tested topics such as related property, business property relief (including exempt assets) and simpler areas such as annual, marriage and spouse exemptions. The question should not pose too much difficulty to a well-prepared and wellpracticed student. However, note that the requirement is primarily for explanations which can be supported by calculations. Therefore, your answer needs to explain clearly in words (not just numbers) the implications for IHT of the lifetime gifts which are all PETs, but become chargeable on death, and then the death estate. As a result of Phil s death on 23 March 2013, IHT will arise on: any potentially exempt transfers (PETs) becoming chargeable as a consequence of his death within seven years of the date of the gift. his estate at death. KAPLAN PUBLISHINGH 3
ACCA P6 (UK): ADVANCED TAXATION IHT on PETs becoming chargeable on death (1) Cash transfers to Phil s son in 2007, 2008 and 2009 being a transfer from one individual to another individual will be regarded as PETs when made, but will now become chargeable as death has occurred within seven years. (2) Transfer to Phil s wife in July 2012. This transfer will be an exempt transfer for IHT purposes which means no IHT at the date of the gift or when Phil dies. (3) Transfer to Phil s son in July 2012. This transfer to his son being a transfer from one individual to another will be regarded as a PET when made, but will now become chargeable as death has occurred within seven years of July 2012. The transfer will be valued using the related property rules with Phil s wife s 25% shareholding counting as related property. As Phil s son still holds the shares in March 2013, business property relief (BPR) will be available at 100%. However, the BPR must be restricted as the company has assets that are held for investment purposes. Therefore only 90% of the value is eligible for relief. Tutorial note All lifetime gifts are PETs, therefore there is no IHT payable. IHT on lifetime gifts as a result of Phil s death There is no IHT due on the gifts in 2007, 2008 and in 2009 as they are covered by the nil rate band of 325,000, as shown below: Gross IHT Chargeable Transfer (GCT) 28.3.07 PET Transfer of value 46,000 Less: AE 2006/07 (3,000) AE 2005/06 (3,000) Chargeable amount 40,000 40,000 Nil 20.6.07 PET Transfer of value 37,000 Less: ME (5,000) AE 2007/08 (3,000) AE 2006/07 (used) (Nil) Chargeable amount 29,000 29,000 Nil 4 KAPLAN PUBLISHING
11.3.08 PET Transfer of value 18,000 Less: AEs (already used) (Nil) Chargeable amount 18,000 18,000 Nil 3.3.09 PET Transfer of value 211,000 Less: AE 2008/09 (3,000) AE 2007/08 (Nil) Chargeable amount 208,000 208,000 Nil Covered by nil rate band 295,000 10.7.12 Inter spouse gift exempt Nil Nil PET 20.7.12 Transfer of value (W1) 501,399 Less: BPR (100% 501,399 90%) (451,259) AE 2012/13 (3,000) AE 2011/12 (3,000) GCT c/f 44,140 NRB at death (March 2013) 325,000 Less: GCTs in 7 yrs pre gift (include PETs which become chargeable on death) (20.7.05 20.7.12) (295,000 above) (295,000) (30,000) Taxable amount 14,140 IHT due on death (14,140 40%) 5,656 Less: Taper relief (20.7.12 to 23.3.13) (< 3 years) (Nil) Less: IHT paid in lifetime (PET) (Nil) IHT payable on death 5,656 Due date (six months from end of the month of death) 30.9.13 Paid by Bradley KAPLAN PUBLISHINGH 5
ACCA P6 (UK): ADVANCED TAXATION Phil: Death estate computation Shares in Queen Ltd (W2) 818,182 Less: BPR (100% 818,182 90%) (736,364) 81,818 Shares in Club Ltd 100,000 Less: BPR (100% 100,000) (100,000) Nil Property used by Queen Ltd (Note 1) 750,000 Less: BPR (50% 750,000) (375,000) 375,000 Property used by Club Ltd (Note 2) 175,000 Less: Outstanding mortgage (75,000) 100,000 Other assets 650,000 1,206,818 Less: Exempt legacy to spouse (325,000) Gross chargeable estate 881,818 NRB at death (March 2013) 325,000 Less: GCTs in 7 yrs pre death (23.3.06 23.3.13) (295,000 above + 44,140) (339,140) (Nil) Taxable amount 881,818 IHT (881,818 40%) 352,727 Payable by Executors Notes (1) Queen Ltd is controlled by Phil and his wife, therefore the property used by this company will qualify for BPR at the rate of 50%. (2) Club Ltd is not controlled by Phil, this property will therefore not qualify for BPR. Tutorial note The exempt legacy is 325,000 given the confines of the syllabus. In fact, where there is an exempt legacy and business property is left in the residue of an estate, the legacy is abated. However, this complication is not within the P6 syllabus. 6 KAPLAN PUBLISHING
Workings (1) Shares in Queen Ltd Valuation at July 2012 Before After Phil 40% (10%) 30% Wife 25% 25% 65% 55% Value of holding 2,100,000 1,450,000 40 Value before (2,100,000 65 ) 1,292,308 30 Value after (1,450,000 55 ) (790,909) Diminution in value = transfer of value 501,399 (2) Shares in Queen Ltd Valuation at 23 March 2013 At 23.3.13 Phil 30% Wife 25% 55% Valuation of 55% holding 1,500,000 30 Value of Phil s shares ( 55 1,500,000) 818,182 (b) (i) Capital gains tax implications Key answer tips This part is a capital gains calculation involving Entrepreneurs relief and gift relief. It is very important to be clear about the interaction of these two reliefs, and to understand that if gift relief is claimed, Entrepreneurs relief and the benefit of the 10% tax rate will be lost. This may mean it is better not to claim gift relief if the recipient of the gift will not be entitled to Entrepreneurs relief on a subsequent disposal (for example because they hold the asset for less than a year, or they do not work for the company). Again, note that the requirement is for explanations. So, be careful not to just give a numerical answer as the majority of the marks will be for explaining clearly the CGT implications. KAPLAN PUBLISHINGH 7
ACCA P6 (UK): ADVANCED TAXATION Disposal to Phil s wife on 10 July 2012 As an inter-spouse gift, this will be treated as a no gain/no loss disposal and will not give rise to a chargeable gain. Disposal to Phil s son on 20 July 2012 This is a disposal to a connected person and therefore market value will be used to give the deemed proceeds figure. 2012/13 Gain qualifying for Entrepreneurs relief Market value 150,000 Less: Cost (650,000/65%) 10% (100,000) Chargeable gain 50,000 Less: Annual exempt amount (see Tutorial note) (10,600) Taxable gain assessable on Phil 39,400 Capital gains tax (39,400 10%) 3,940 As Phil worked for the company and held at least 5% of the shares for at least 12 months, he will qualify for Entrepreneurs relief (see Tutorial note). Base cost of shares to Bradley = 150,000 (market value of 10% interest in July 2012) Tutorial note 1 Entrepreneurs relief is only available for shares in trading companies. A trading company with investments will qualify if the investments are not substantial. HMRC regard 20% to be substantial, therefore Queen Ltd will qualify as a trading company as its investments only represent 10% of its total assets. 2 Phil has no other chargeable disposals in 2012/13, therefore all of the annual exempt amount is available. 3 All of Phil s earlier lifetime gifts are cash gifts, and are therefore exempt from CGT. Disposal of Bradley s shares in December 2013 The proposed disposal by Phil s son Bradley in December 2013 will be of a 20% holding from a 40% holding (10% gifted by his father in July 2012 and 30% inherited from his father in March 2013). The shares will be pooled, and the cost of the shares sold will be taken as half of the total cost. 8 KAPLAN PUBLISHING
2013/14 Disposal of 20% holding from pool Sale proceeds 550,000 Less: Cost (W) (484,091) Chargeable gain 65,909 Less: Annual exempt amount (10,600) Taxable gain 55,309 Capital gains tax (58,309 28%) 15,487 Working: Share pool Acquisitions No of shares Cost July 2012 10% 150,000 March 2013 (see Tutorial note) 30% 818,182 40% 968,182 Disposal (20/40) (20%) (484,091) Pool c/f 20% 484,091 Tutorial note The cost of the shares inherited on Phil s death is the probate value, i.e. the value included in Phil s death estate. (ii) If gift relief is claimed Disposal to Phil s son Bradley 20 July 2012 The gain of 50,000 would have been deferred against the base cost of the shares to Bradley (Note below). No chargeable gain would arise on Phil in 2012/13. Phil s Entrepreneurs relief on the shares would be lost. Phil s annual exempt amount for 2012/13 would be wasted. The base cost of the shares to Bradley would be 100,000 (150,000 market value 50,000 gain). KAPLAN PUBLISHINGH 9
ACCA P6 (UK): ADVANCED TAXATION Tutorial note Gift relief is not restricted by CBA/CA as although surplus cash balances are excepted assets for IHT purposes, cash is an exempt asset for CGT. (c) Disposal of Bradley s shares December 2013 Disposal of 20% holding from share pool The base cost of the shares acquired in July 2012 and thus the total pool cost would be 50,000 lower. This would reduce the base cost for the shares sold by 25,000 (half of 50,000), and therefore the gain arising on the disposal would be correspondingly higher. Where gift relief is claimed on a lifetime gift, any IHT payable as a result of the gift is an allowable deduction in the capital gain computation when the donee sells the asset. Bradley can therefore deduct 5,656 (part (a)) from the gain that is chargeable to capital gains tax. However, as there will be no Entrepreneurs relief on the disposal by Bradley, the tax payable on the chargeable gain will be at 28% instead of 10%. This means that the total tax payable with a gift relief claim will be higher. It is therefore advisable for gift relief not to be claimed in this instance. Deed of variation Key answer tips This part covers the commonly tested topic of deeds of variation. There is a slight twist here in that the question asks for the disadvantages of making such a deed, and the answer covers the possibility of challenge by HMRC if the new beneficiary under the deed simply gifts the assets back to the original beneficiary in the future. However, the remainder of the answer is very standard material and provides easy marks if you have learnt the rules. Tax saving Phil is survived by his wife, June and son, Bradley. He has left 325,000 to June which is an exempt legacy, but the remainder of the estate is chargeable. IHT on Phil s estate can be saved if his will is varied to leave more assets to June. All of the assets could be left to June and no IHT would be payable on Phil s death. June could then make lifetime gifts to Bradley in the future to pass on both Phil s and her assets. Lifetime gifts can be planned to ensure the maximum use of exemptions such as the normal expenditure out of income and annual exemptions. 10 KAPLAN PUBLISHING
As these gifts will be PETs, there will be no IHT payable if the spouse lives for seven years after the gifts. However, even if she dies within seven years, IHT will have been saved as the value of the gift is frozen at the time of the gift and taper relief is available after three years. Potential disadvantages in varying the terms The use of a deed of variation is a useful tax planning tool. However, care should be taken in varying the terms of a will in favour of an exempt person, where the intention is for that person to subsequently gift assets to the original beneficiary of the will. HMRC may challenge the variation where they believe that there is a series of associated operations put in place to deliberately avoid a tax liability. In addition, in entering into a deed of variation, Bradley must formally relinquish his right to his inheritance in favour of his mother. He must do so voluntarily and with no expectation or right of any future consideration (i.e. a promise of future gifts). He must therefore be happy to give up his right and trust his mother to pass the assets to him in the future either during her lifetime or on her death. Conditions required for a valid deed of variation The deed must: Be in writing and signed by all beneficiaries that are affected by the deed. Not be made for any consideration. Be executed within two years of death. State that it is intended to be effective for tax (IHT and/or CGT) purposes. ACCA marking scheme Marks (a) IHT arises on: PETs within 7 years of death 0.5 The death estate 0.5 IHT on PETs at death: Cash transfers to son 0.5 Transfer to wife exempt 0.5 Shares transferred to son 0.5 Related property rules 1.0 BPR explanation 1.0 Diminution in value 2.0 BPR calculation 1.0 Annual exemptions 0.5 each 3.0 Marriage exemption 0.5 NRB 0.5 IHT due on death 0.5 Taper relief none available 0.5 Lifetime tax paid none 0.5 Due date 0.5 IHT on death estate: Related property re Queen shares 0.5 BPR on Queen shares 1.0 BPR on Club shares 0.5 BPR on property used by Queen 1.0 No BPR on property used by Club 1.0 Outstanding mortgage 0.5 Exempt legacies 0.5 GCTs in last 7 years 0.5 No NRB available 0.5 IHT at death 0.5 20.0 Max 16.0 KAPLAN PUBLISHINGH 11
ACCA P6 (UK): ADVANCED TAXATION Marks (b) (i) Inter-spouse gift no gain / no loss 1.0 Disposal to son connected person use market value 0.5 Gain before reliefs 1.0 Annual exempt amount 0.5 Entrepreneurs relief: tax at 10% 1.0 Shares acquired via gift and inheritance pooled 1.0 Additions to pool 0.5 each 1.0 Disposals from pool 1.0 Cost of shares 0.5 Annual exempt amount 0.5 CGT at 28% 0.5 8.5 Max 7.0 (ii) 0.5 each valid point Max 4.0 (c) 0.5 each valid point Max 4.0 Appropriate format and presentation 2.0 Effective communication 2.0 Max 4.0 Total 35 2 DUNCAN MCBYTE Key answer tips This is a fairly straightforward employment income question, covering various benefits, termination payments and share option schemes. Part (a) requires explanations and calculations of the income tax and NIC suffered by an employee (but not the employer) as well as income tax on employment income. It covers time apportionment, a termination bonus (which is taxable as it is contractual), living accommodation, mileage allowance, a beneficial loan, use of company assets, other payments on behalf of the employee, deductible expenses and share options. Part (b) is a written question on share option schemes. It is an important exam skill to be able to write about the implications of the tax rules, not just to apply them in a numerical calculation. Part (c) involves recognition of a qualifying furnished holiday letting, followed by application of the rules regarding FHLs to the numbers in the question. 12 KAPLAN PUBLISHING
(a) Income tax and NIC implications of remuneration package Duncan earns over 8,500 p.a. and is therefore a P11D employee. Salary The salary of 65,000 will be assessed as employment income on the receipts basis. It will be liable to both income tax and NICs. There are no NIC implications for Duncan as regards any other aspect of the remuneration package, therefore Duncan s NIC liability for 2012/13 will be: (42,475 7,605) 12% 9/12 3,138 (65,000 42,475) 2% 9/12 338 3,476 Termination bonus The termination bonus of 40,000 will be taxable in full since Duncan is contractually entitled to it. It is taxable in 2015/16; the tax year in which Duncan receives it. The termination bonus is also liable to NICs in 2015/16. Tutorial note Benefits of employment are liable to Class 1A NICs, but this is paid by the employer. There is no NIC liability for the employee on benefits. Living accommodation Duncan will be assessed to income tax (but not NICs) on the benefit of the living accommodation provided to him. There will be an additional benefit based on the market value of 170,000, since the apartment cost in excess of 75,000 and was purchased more than six years before first being provided. The benefits assessed in 2012/13 will be: Rateable value (6,700 9/12) 5,025 Additional benefit (170,000 75,000) 4% 9/12 2,850 7,875 Mileage allowance The mileage allowance received will be tax free as it falls within HMRC s authorised mileage allowance payment (AMAP). However, Duncan can make an expense claim to reduce his taxable employment income for 2012/13 as follows. KAPLAN PUBLISHINGH 13
ACCA P6 (UK): ADVANCED TAXATION Duncan travelled 13,500 (1,500 9 months) business miles in 2012/13: 10,000 miles at 45p 4,500 3,500 miles at 25p 875 13,500 HMRC AMAP 5,375 Less: Mileage allowance received (13,500 at 30p) (4,050) Allowable deduction 1,325 As Duncan only receives 4,050 from his employers towards his business miles for 2012/13 and HMRC mileage allowance gives tax relief for 5,375, the difference of 1,325 will reduce his employment income and his income tax liability for 2012/13. Beneficial loan Duncan will be assessed to income tax (not NICs) on the difference between the interest paid on the loan and the official rate of interest. Based on the average method, the taxable benefit for 2012/13 is as follows: 60,000 + 50,000 1,650 Interest at official rate 4% 9/12 2 Less: Interest paid (425) 1,225 Based on the precise method, the taxable benefit for 2012/13 is as follows: 1 July 2012 to 31 December 2012 (60,000 4% 6/12) 1,200 1 January 2013 to 6 April 2013 (50,000 4% 3/12) 500 1,700 Less: Interest paid (425) 1,275 Duncan will not elect for the precise basis as he will have a higher assessable benefit. HMRC are unlikely to insist on the precise basis applying as the difference in the two methods is not material and there is no evidence of deliberate manipulation of the repayments to affect the assessable benefit. The assessable loan benefit for 2012/13 is therefore 1,225. 14 KAPLAN PUBLISHING
Use of computer Duncan must pay income tax on the benefit of the use of the computer of 180 (1,200 20% 9/12). Other payments Only the cost of the sports club membership of 800 will be assessed to income tax as a taxable benefit on Duncan for 2012/13. The subscription of 125 will be assessed, but a corresponding expense deduction can then be claimed since it is a professional subscription. The net effect on his employment income is therefore Nil. No taxable benefit arises in respect of the payment of liability insurance or the cost of work-related training as they are specifically exempted from tax. Share options There will be no income tax or NICs payable in respect of the share options. No employment income charge will arise either at the time of grant or upon the exercise of the options as the options have been granted under an approved scheme. The exemption is available since the total market value of Duncan s options at the time of grant (15,000 1.75 = 26,250) does not exceed 30,000, and the options will not be exercised less than three years from the time of grant. Employment income summary 2012/13 Salary (65,000 9/12) 48,750 Accommodation benefit 7,875 Loan benefit 1,225 Use of computer benefit 180 Sports club membership 800 ICCC membership 125 58,955 Less: Allowable expenses Mileage allowance deficit (1,325) Subscription to professional body (125) Employment income 57,505 Collection of tax on benefits Income tax The income tax on Duncan s benefits for 2012/13 will be collected under the self-assessment regime, and will be payable by 31 January 2014. In the second tax year 2013/14, the income tax will be collected through the PAYE system by adjusting Duncan s tax code. It is likely that Duncan will have a negative code, which will be indicated by the letter K appearing in front of the code. NICs There are no NICs payable by Duncan in respect of the benefits of employment received. KAPLAN PUBLISHINGH 15
ACCA P6 (UK): ADVANCED TAXATION (b) (c) Benefit of an approved share option scheme If the share options had not been granted under the company share option scheme, an employment income charge would arise at the time that the share options were exercised. The employment income charge would be liable to income tax and, as the shares are readily marketable securities (i.e. shares in a quoted company), Class 1 NICs would be payable. This charge on 30 June 2015 would be based on the market value at that date less the amount paid for the shares. The total assessment would therefore have been 48,750 [15,000 3.25 (5.00 1.75)]. On the subsequent disposal of the shares, the employment income charge would be deducted from the chargeable gain arising. Therefore, the options are liable to an income tax and NIC charge on exercise and a lower gain on disposal. Granting the options under the company share option scheme is therefore beneficial since: (i) (ii) the tax liability is postponed until such time as the shares are actually disposed of, the increase in value to the exercise date is subject to capital gains tax, not income tax and NIC, and (iii) the resulting CGT liability on the disposal will be lower than the income tax and NIC liability based on the above employment income assessment due to the availability of the annual exempt amount for CGT and the 28% rate of tax (assuming Duncan is still a higher rate taxpayer). Property business profits Duncan s letting of his main residence should qualify to be treated as a trade under the furnished holiday letting rules. It is available all year and is to be let for 154 days (22 7 days), so that it is both available for letting for at least 210 days and it will be let for at least 105 days. The assessment is therefore calculated using the trading income rules and capital allowances on plant and machinery will therefore be available. Duncan can also deduct the interest in calculating the profits from renting. His profit for 2012/13 will be as follows: Rental income 18,000 Less: Expenses Letting agency (18,000 22.5%) 4,050 Running costs 900 Interest (6,400 9/12) 4,800 Capital allowances (6,000 100%) 6,000 (15,750) Property business profits 2,250 16 KAPLAN PUBLISHING
Tutorial note Capital allowances are given on the furniture instead of wear and tear allowance. ACCA marking scheme Marks (a) Termination bonus taxable in full 1.0 NIC liability 1.0 No NIC on benefits 0.5 Living accommodation: Rateable value 0.5 Explanation of using MV not cost 1.0 Additional benefit 1.0 Mileage allowance: Amount received is tax free 0.5 Expense claim calculation 1.5 Allowable deduction 1.0 Beneficial loan: Assessed based on official rate 1.0 Average method 1.0 Precise method 1.0 Use of computer 1.0 Sports club membership 0.5 Professional subscription 0.5 Liability insurance and work related training exempt 0.5 Share options: No tax at grant or exercise approved scheme 1.0 Conditions satisfied 1.5 Calculation of employment income 1.0 Collection of 2012/13 income tax on benefits 0.5 Collection of 2013/14 income tax on benefits 0.5 18.0 Max 17.0 (b) Unapproved scheme: Charge at exercise 1.0 Calculation of charge 1.0 Approved: Postponement of liability until sell shares 1.0 Less tax payable: CGT 28% less AEA 1.0 4.0 Max 3.0 (c) Meets conditions for FHL 2.0 Calculation using trading income rules 0.5 Rental income 0.5 Letting agency fees 0.5 Running costs 0.5 Interest 0.5 Capital allowances 0.5 5.0 Max 5.0 Total 25 KAPLAN PUBLISHINGH 17
ACCA P6 (UK): ADVANCED TAXATION 3 PIERRE Key answer tips This is a detailed property income question, covering many aspects of tax in this area, including capital gains in respect of rental property and PPR relief. There are a couple of more challenging areas in this question, such as the treatment of reverse premiums and small part disposals of land, but even if you do not know how to deal with these items, you should still be able to achieve enough marks to pass the question. It is important to lay out your answer clearly the calculation of total property business income is shown first below, followed by clearly labelled workings in respect of each property. You should make it as easy as possible for the marker to give you credit for your workings by labelling and referencing them clearly. (a) Property business income assessment 2012/13 Income: Property 1 (W1) 2,070 Property 3 (W2) 23,150 Property 4 (W3) 2,917 Less: Expenses Property 3 (1,500) Property 4 (1,000 + 3,000) (4,000) Property business income 22,637 Workings (W1) Property 1 As Pierre is renting part of his main residence on a furnished basis rent a room relief is available. Total exemption of this income will not, however, be possible because his gross rents from this source exceed the limit of 4,250. Pierre will therefore have the option of either: (i) Claiming rent a room relief and being taxed on the excess rents over the 4,250 limit: Rents 6,320 Less: Limit (4,250) 2,070 18 KAPLAN PUBLISHING
(ii) Being taxed on this rental income in the normal way (i.e. rents less allowable expenses including the wear and tear allowance): Rents 6,320 Less: Expenses (720) Interest (2/6 4,000) (1,333) Wear and tear (10% 6,320) (632) 3,635 Pierre should, therefore, make the necessary election for rent a room relief by 31 January 2015 (i.e. 12 months from the 31 January following the end of the relevant tax year). It should be noted that the nomination of property 2 as his main residence for PPR purposes should not prevent property 1 being treated as his main residence for rent a room relief purposes. This is because the CGT nomination is specifically stated to be for PPR purposes only. (W2) Property 3 Rental income: 9,000 2/12 1,500 9,000 7/12 5,250 Assessable premium: 20,000 (Note) (51 10) / 50 16,400 23,150 Note: Total premium = cash received of 10,000 plus the 10,000 increase in value arising from structural improvements = 20,000. Tutorial note The premium assessable as property income could be calculated as follows: Premium 20,000 Less: 20,000 2% (10 1) (3,600) Assessable premium 16,400 KAPLAN PUBLISHINGH 19
ACCA P6 (UK): ADVANCED TAXATION (W3) Property 4 Rent from 6 September 2012: (5,000 7/12) 2,917 The inducement payment is likely to be caught by the reverse premium legislation and will therefore be taxed as a trading receipt of Les Amis Limited in that company s corporation tax computations. No relief is available to Pierre as he is not a dealer in land and therefore cannot treat the payment as a trading expense. (b) Capital gain on disposal of the garden Property 2 Sale proceeds 19,600 Less: Deemed cost of part disposed of (7,871) 19,600 40,000 19,600 + 80,000 Chargeable gain 11,729 Less: Annual exempt amount (10,600) Taxable gain 1,129 However, this disposal will qualify as a small land disposal as the proceeds are not more than 20% of property value before disposal and, are less than 20,000. Pierre may therefore elect to deduct the sale proceeds from the 40,000 original cost to give a base cost for future disposal purposes of 20,400 (40,000 19,600). Whether Pierre wishes to make the election will depend on his future disposal plans. The election will save CGT on the taxable gain of 1,129 giving a CGT saving of 203 (1,129 18%), as the gain will fall into Pierre s basic rate band. (c) Property 2 Principal Private Residence Relief ( PPR ) An individual is entitled to PPR relief in respect of only one residence. It is important therefore that Pierre makes an election to nominate which of his two residences will be treated as his main residence for the purposes of this relief. Such an election needs to be made within two years of the acquisition of the second property (i.e. in Pierre s case by 30 June 2013). The two-year period runs from the acquisition of the property and not from the first date that the second property started being used as a residence. In the absence of such an election HMRC will decide for Pierre which property is to be treated as his main residence. There is a danger that they will select property 1 because Pierre seems to live in this property for more time than property 2. This could be detrimental to Pierre as his current plan is to retain property 1 and dispose, either partially or entirely, of property 2. 20 KAPLAN PUBLISHING
If a nomination for property 2 is made and accepted by HMRC it will run from the time Pierre started using this property as a residence (i.e. from 1 July 2012) to the date the property is disposed or a further election/variation of original election is made. The implication for property 1 is that this nominated period will be a chargeable period of occupation for determining any potential future gain on a disposal of this property. Pierre will therefore have to balance this against any short term CGT savings that he may make on a disposal of property 2. It should further be noted that HMRC could reject the nomination of property 2 if, for example, they considered that this property was simply acquired for the purposes of resale or is being used as temporary accommodation. Future Disposals With regard to the future proposed disposal(s) Pierre will need to carefully consider the order in which he sells any further portions of this property. The following possibilities appear to exist. 1 Sells the house and retains a portion of the garden for future sale Whilst it is likely that the sale of the house itself would qualify for the PPR exemption (subject to any restrictions for non-occupation as main residence), case law has determined that the subsequent sale of any residual land would not qualify for PPR relief. This is because at this point the land no longer forms part of a main residence. A future chargeable gain is therefore likely to arise. There is the further issue that if the house is sold by 30 June 2014 (i.e. within 36 months of acquisition) there will be no restriction of the PPR exemption. This is because, providing there has been some actual occupation (which there has), the last 36 months of ownership of the property will always be taken as deemed occupation (if not already actual occupation) and therefore exempted. This may well, therefore, entirely cover both the gain on the disposal of the house and the earlier part disposal referred to above. 2 Sells a portion of the garden and retains the house for future sale. In this case the PPR exemption is likely to apply to the disposal of part of the garden (being less than 0.5 hectares) and also any eventual disposal of the house itself (again subject to any restrictions for non-occupation as main residence). If Pierre has any choice this is therefore likely to be the preferred sequence. KAPLAN PUBLISHINGH 21
ACCA P6 (UK): ADVANCED TAXATION ACCA marking scheme Marks (a) Property business income assessment for 2012/13 1.0 Rent a room relief available 1.0 Taxable amount if rent a room relief claimed 1.0 Taxable amount if taxed normally 1.5 Deadline for election 1.0 Rent on property 3 1.0 Assessable premium 2.0 Rent on property 4 0.5 Treatment of inducement payment 1.0 10.0 Max 8.0 (b) Deemed cost of part disposed 1.5 Annual exempt amount 0.5 Qualifies as small part disposal of land 1.0 Deduct sale proceeds from original cost 1.0 Current tax saving 1.0 5.0 Max 4.0 (c) 1 mark for each valid point Max 8.0 Total 20 4 ANWAR CHRISTOPHER Key answer tips Overseas aspects of tax for individuals are commonly tested. This is a topic which lends itself well to multi tax scenario questions; however this question concentrates on the income tax consequences with just two marks at the end on inheritance tax. It considers the position of a long term UK resident individual who is not UK domiciled. Part (a) is purely written and requires an explanation of how Anwar will be taxed, given his tax status, the choices available and a conclusion regarding which basis of assessment he should choose. Part (b) is purely computational and requires the computation of his income tax liability based on an arising basis. Therefore, even if you did not correctly identify the correct basis of assessment in part (a), full marks could still be obtained in part (b). Part (c) is a straightforward calculation of self assessment payments. Part (d) requires a written explanation of treatment of inter-spouse transfers for inheritance tax purposes. 22 KAPLAN PUBLISHING
(a) Options for assessment to income tax non-uk domiciles Key answer tips In these questions, it is important to be able to determine someone s residence, ordinary residence and domicile and then to apply the appropriate rules for their status to the facts in the question. Here you are told that Anwar has lived in the UK for ten years so he is clearly resident and ordinarily resident, but you are also told that he is not UK domiciled. As his unremitted overseas income exceeds 2,000 he has the choice between the arising and remittance basis. Note that whichever he chooses, UK income is always taxed on an arising basis. For 2012/13 Anwar is resident and ordinarily resident in the UK, but not UK domiciled. As his unremitted overseas income exceeds 2,000, (he has overseas income of 23,000 and has remitted less than 21,000) he has the choice of being assessed on his overseas income either on the arising basis or the remittance basis as follows: Arising basis All UK income on an arising basis Overseas income on an arising basis Full personal allowances available This means that all of the 23,000 overseas earnings would be taxed in the UK. Alternatively, Anwar can elect to use the remittance basis. Remittance basis If the remittance basis is claimed, he will still be assessed on his UK income on an arising basis, but his overseas income will only be assessed if remitted to the UK Anwar has remitted 18,000 to the UK but he can claim that the 10,000 used to lend money to an unquoted trading company is not classed as a remittance for this purpose. This means that Anwar would only be assessed on the 8,000 transferred from his foreign bank account, not the full 23,000 earned However, there will be no personal allowance available or annual exempt amount for CGT Christopher will also have to pay a 30,000 remittance basis charge as he has been resident and ordinarily resident for more than 7 out of the previous 9 tax years. Conclusion Anwar should not claim the remittance basis for 2012/13 as this will clearly result in a much higher tax charge. KAPLAN PUBLISHINGH 23
ACCA P6 (UK): ADVANCED TAXATION Tutorial note Remember that whichever basis he chooses, UK income is always taxable on an arising basis. Anwar has been in the UK for the last 10 years and hence would be liable to a remittance basis charge of 30,000. When he has been in the UK for 12 out of the last 14 years his potential remittance basis charge rises to 50,000. (b) Income tax computation 2012/13 Key answer tips This part consists of a fairly detailed income tax computation. You are told to do this calculation on the basis that he has chosen to be taxed on the arising basis. You need to work through the narrative in the question to identify all of Anwar s sources of income. This includes interest from the capital bonds, which you are expected to calculate at the rate given, and also identify the tax on this interest which will have been deducted at source. There is also qualifying loan interest, as Anwar has borrowed money to invest in a close company (Christopher Ltd is clearly close as Anwar is the sole shareholder). This interest can therefore be deducted from his total income. Finally there is a double tax relief calculation. This must be done by calculating the tax that would be payable if Anwar had not received any foreign income and comparing this with the income tax liability. You cannot simply calculate the UK tax on foreign income by applying UK rates, as it has been partly taxed at the basic rate and partly at the higher rate, and it has also pushed the savings income and dividend income into the higher rate band. Note that it is not compulsory to lay out the income tax computation in this four column format, and it may be quicker to simply include all income in one column and then do a short calculation to analyse the types of income. Total income Other income Savings income Dividend income Trading income 15,000 15,000 Employment income Christopher Ltd (8 1,000) 8,000 8,000 Initial Ltd (UK duties) 7,000 7,000 (Pakistan duties) 23,000 23,000 Interest 78 78 National Airlines (800 9.75%) Glucozade dividends (270 100/90) 300 300 Total income 53,378 53,000 78 300 24 KAPLAN PUBLISHING
Total income Other income Savings income Dividend income Total income (brought forward) 53,378 53,000 78 300 Less: Interest paid (Note) (6,400) (6,400) Net income 46,978 46,600 78 300 Less: PA (8,105) (8,105) Taxable income 38,873 38,495 78 300 Income tax 34,370 at 20% (other income) 6,874 4,125 at 40% (other income) 1,650 38,495 78 at 40% (savings) 31 300 at 32.5% (dividends) 97 38,873 8,652 Less: Double tax relief (W) (5,507) Income tax liability 3,145 Less: UK tax deducted at source Dividends (300 10%) (30) Interest (78 20%) (16) PAYE (950) Income tax payable 2,149 Tutorial note The loan interest paid to Abbeyminster Bank is paid for a qualifying purpose, the making of a loan to a close company in which Anwar has a material interest. The interest payable to Abbeyminster is therefore eligible for relief as a deductible payment. KAPLAN PUBLISHINGH 25
ACCA P6 (UK): ADVANCED TAXATION Working: Double taxation relief Double tax relief is available on the Pakistan source income on the basis of the lower of the Pakistan tax suffered or the UK tax on the Pakistan income, treating the Pakistan income as the top slice. The UK tax excluding the Pakistan income is calculated as follows: Other income (38,495 23,000) 15,495 Savings income 78 Dividend income 300 Revised taxable income 15,873 Income tax 15,495 at 20% (other income) 3,099 78 at 20% (savings) 16 300 at 10% (dividends) 30 15,873 3,145 UK tax on Pakistan income (8,652 3,145) = 5,507 (Note) Pakistan tax suffered = (23,000 35%) = 8,050 DTR is therefore 5,507 Tutorial note Alternative calculation of DTR: If the top slice of the 23,000 employment income is removed, the tax saving will be: Employment income removed (23,000 20%) 4,600 Amount in the HR band now taxed at lower rate: Employment income (4,125 (40% 20%)) 825 Savings income (78 (40% 20%)) 15 Dividends (300 (32.5% 10%)) 67 Tax saving 5,507 26 KAPLAN PUBLISHING
(c) Self assessment balancing payment year ended 5 April 2013 Key answer tips This part is a straightforward calculation of the balancing payment due. Remember this will include Class 4 NICs and capital gains tax. (d) Income tax payable (part (b)) 2,149 Class 4 NIC liability (15,000 7,605) 9% 666 2,815 Chargeable gain (per question) 185,000 Less: Annual exempt amount (10,600) Taxable gain 174,400 Capital gains tax payable (174,400 28%) 48,832 Total tax payable 51,647 Less: Payments on account 31.1.2013 (2,600) 31.7.2013 (2,600) Balancing payment due 31.1.2014 46,447 Inheritance tax consequences of transferring property to spouse Key answer tips This part requires a written explanation of inter-spouse transfers for inheritance tax purposes. Make sure you consider both spouses domicile status and mention the treatment of both UK and non-uk situated assets. As Anwar is not domiciled in the UK, the property he owns that is located outside the UK is excluded property. Providing he transfers such property to another non UK domiciled person there is no UK inheritance tax charge. If, however, he were to transfer such property to Wendy, who is UK domiciled, the property becomes chargeable to inheritance tax in the UK when she subsequently transfers it. Anwar should not therefore transfer any of his overseas assets (e.g. his interest in the Peshawar estate) to Wendy. Anwar s UK situated assets are chargeable to UK inheritance tax in any event. KAPLAN PUBLISHINGH 27
ACCA P6 (UK): ADVANCED TAXATION Tutorial note There is no limit to the value of assets Anwar can transfer to Wendy (i.e. non-uk domiciled individual transfer to UK domiciled individual). The spouse exemption is only limited to 55,000 where a UK domiciled spouse transfers property to a non UK domiciled spouse. This is because the property transferred would become overseas property owned by a non-uk domiciled individual and it would thereby become excluded property. ACCA marking scheme Marks (a) 1 mark for each valid point Max 6.0 (b) Trading income 0.5 Employment income: Christopher Ltd 0.5 Initial Ltd UK duties 0.5 Initial Ltd Pakistan duties 0.5 Interest 0.5 Dividends 0.5 Qualifying interest payment 1.0 Personal allowance 0.5 Tax calculation 1.5 Double tax relief: Revised taxable income 1.0 Revised income tax 1.0 DTR 0.5 Tax at source on dividends 0.5 Tax at source on interest 0.5 PAYE 0.5 10.0 Max 9.0 (c) Income tax payable from part (b) 0.5 Class 4 liability 1.0 Capital gains tax liability 1.0 Deduct payments on account 1.0 3.5 Max 3.0 (d) 0.5 mark for each valid point Max 2.0 Total 20 28 KAPLAN PUBLISHING
5 MOLLY MOP Key answer tips This is a classic income tax and IHT question, where the income tax calculated in part (a) is then included in the death estate calculation in part (b). In order to deal with both parts of the question you need to identify the information relating to Molly s income and the information relating to the capital value of her assets. (a) Molly Mop Income tax computation 2012/13 Key answer tips The income tax computation includes interest from income bonds and government stocks, both of which are received gross, as well as dividends from a unit trust, which are treated just like normal dividends. It also includes trust income which is received net of 50% tax, and must be grossed up, and then the tax can be deducted from the income tax liability. Remember that an investment in a VCT generates 30% income tax relief. Earned income State pension (107 52) 5,564 Private pension 12,200 Savings income Interest on government stocks (100,000 4%) 4,000 Building society interest (150,000 5.5%) 8,250 Interest on bonds (10,000 7%) 700 Interest on ISAs (exempt) Nil 12,950 Other investment income Trust income (1,500 100/50) 3,000 Dividend income Shawl plc (20,000 27p 100/90) 6,000 Bit-Part Ltd (45,000 10p 100/90) 5,000 Global Trust (450 100/90) 500 11,500 Total income 45,214 Less: PAA (see Tutorial note) (8,105) Taxable income 37,109 KAPLAN PUBLISHINGH 29
ACCA P6 (UK): ADVANCED TAXATION Analysis of income: Dividends Savings Other income 11,500 12,950 (37,109 11,500 12,950) = 12,659 Income tax 12,659 20% (other income) 2,532 12,950 20% (savings) 2,590 8,761 10% (dividends) 876 34,370 2,739 32.5% (dividends) 890 37,109 6,888 Less: VCT relief (10,000 30%) (3,000) Income tax liability 3,888 Less: Dividends (11,500 10%) (1,150) Savings (8,250 20%) (1,650) Trust income (3,000 50%) (1,500) Income tax repayable (412) Tutorial note Molly s level of total income results in her PAA being fully abated to the normal personal allowance. (b) Inheritance tax liability as a result of Molly s death in April 2013 Key answer tips The inheritance tax computation includes some BPR with excepted assets, units in a global trust (which are always valued at the lower quoted price), an ISA account (remember this is taxable for IHT purposes), as well as various other assets. You must also deal with the transfer of the husband s unused nil rate band and the new 36% rate of IHT where a large enough charitable legacy is made. You are asked to indicate who is liable for the tax and when it is due, and there are marks for spotting that the tax in respect of the property can be paid by instalments. 30 KAPLAN PUBLISHING
[ Lifetime gifts CLT in June 2007 Transfer of value 160,000 Less: AE 2007/08 (3,000) AE 2006/07 b/f (3,000) Net chargeable amount 154,000 No inheritance tax is payable during Molly s lifetime on this gift, nor on her death, as the gift is covered by the nil rate band of 300,000 (at the time of the gift) and 325,000 (on death). The gross chargeable transfer (GCT) to carry forward is therefore 154,000 (154,000 + Nil). Death estate Main residence 245,000 Ordinary shares in Shawl plc (20,000 4.14 (410 + ¼ (426 410)) 82,800 Ordinary shares in Bit-Part Ltd 236,250 Less: BPR (100%) (W1) (123,750) 112,500 UK government stocks 100,000 91p (90 + ¼ (94 90)) 91,000 Units in Global Trust (25,000 2.10) 52,500 Building society deposits 150,000 NS&I Pensioners Guaranteed income bonds 10,000 Shares in VCT 10,000 ISA account 3,210 Chattels, cash and other assets 165,000 Income tax repayable (part (a)) 412 922,422 Less: Charity legacy (60,000) Gross chargeable estate 862,422 NRB at death (April 2013) 325,000 Plus: Husband s unused NRB (W2) 225,000 550,000 Less: GCT in 7 yrs pre death (April 2006 April 2013) (154,000) NRB available (396,000) Taxable amount 466,422 IHT (466,422 36% (W3)) 167,912 Estate rate = 167,912/862,422 100 = 19.470% KAPLAN PUBLISHINGH 31
ACCA P6 (UK): ADVANCED TAXATION IHT is payable as follows: IHT of 167,912 is payable by the executors, of which 47,702 (245,000 19.470%) in relation to the main residence can be paid in instalments (see Tutorial note). The IHT not payable by instalments would be due on the earlier of 31 October 2013 or the delivery of the account by the personal representatives. The IHT payable by instalments would be due in ten equal annual instalments commencing on 31 October 2013. Tutorial note The IHT in relation to the Bit-Part Ltd unquoted shares can also be paid by instalments, as they satisfy the detailed specific conditions in the IHT instalment option legislation. However, knowledge of this level of detail is not required in the examination. Workings (W1) Business Property Relief BPR at the rate of 100% is available in respect of the business asset element of the 45,000 ordinary shares in Bit-Part Ltd as they are a holding in an unquoted company. Although Molly has owned the shares for less than two years, they were acquired upon her husband s death and would have qualified for business property relief at that date. The amount of BPR is restricted for excepted assets as follows: 236,250 (1,050,000 500,000) 1,050,000 = 123,750 (W2) Transfer of unused nil rate band from husband Molly s husband died on 7 April 2012. The nil rate band at that date was 325,000 of which 100,000 would have been used to cover the non exempt legacy to the children. The unused amount of 225,000 can be transferred to Molly. There is no need to calculate a proportion of the nil rate band to transfer as the band is unchanged at 325,000 from April 2012 to April 2013. (W3) Rate of tax to use for the death estate Taxable amount 466,422 Add back charitable legacy 60,000 Baseline amount 526,422 Apply 10% test 52,642 As the charitable legacy is more than 52,642, the reduced rate of 36% can apply to calculate the tax on the estate. 32 KAPLAN PUBLISHING
ACCA marking scheme Marks (a) State pension 0.5 Private pension 0.5 Interest on government stocks 0.5 Building society interest 0.5 Interest on pensioners income bonds 0.5 Interest on ISA exempt 0.5 Trust income 0.5 Dividend income: Shawl plc 0.5 Bit-Part Ltd 0.5 Global Trust 0.5 PAA 0.5 Analysis of income 0.5 Tax calculation 1.5 Tax at source on dividends 0.5 Tax at source on interest 0.5 Tax at source on trust income 0.5 Max 9.0 (b) Lifetime gift covered by NRB 0.5 Main residence 0.5 Shawl plc shares 0.5 Bit-part Ltd shares 0.5 BPR 1.5 Recognition that minimum ownership is met as inherited 1.0 Government stocks 0.5 Unit trust 0.5 Building society deposits 0.5 NS%I bonds 0.5 Shares in VCT 0.5 ISA account 0.5 Income tax repayable from part (a) 0.5 Exempt legacy to charity 0.5 Transfer husband s NRB 0.5 GCTs in seven years before death 0.5 IHT payable 0.5 Reduced rate of 36% applicable 1.0 Estate rate 0.5 IHT payable by executors 0.5 IHT remain residence can be paid in instalments 0.5 Due date for IHT not payable by instalments 0.5 Due with delivery of account by personal representatives if earlier 0.5 Due dates for instalments 0.5 14.0 Max 11.0 Total 20 KAPLAN PUBLISHINGH 33