Chapter 4 Taxation of Investors and Investments 16 questions 11
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1. Personal Taxation Fiscal year (tax year) Individuals and trusts subject to UK income tax: - Calculate taxable income from and capital gains for a fiscal year - Companies pay corporation tax, not income tax or capital gains tax Fiscal year: 6 April 5 April Financial year Companies subject to UK corporation tax Financial year: 1 April 31 March Tax Avoidance vs. Tax Evasion It is important to understand the difference between tax avoidance and tax evasion: Tax avoidance legally minimising tax liabilities Tax evasion (or tax fraud) illegally hiding/not declaring the true nature of income and capital gains Tax evasion incurs penalties and ultimately a prison sentence. If an employee of an authorised firm suspects that their client is involved in tax evasion, they must report the activity to their MLRO, who will report to the NCA. 13
7. Residency and Domicile Residence Automatic overseas resident: - First overseas test Present in the UK for fewer than 16 days in the current fiscal year - Second overseas test Present in the UK for fewer than 46 days in the current fiscal year Not present in the UK during the last three fiscal years - Third overseas test Work full-time overseas Spend fewer than 91 days in the UK No more than 30 working days in the UK 14
7. Residency and Domicile Residence Automatic UK resident: - First UK resident test Present in the UK for at least 183 days in a fiscal year - Second UK resident test Their only home (or main home) is in the UK - Available for use for 91 days or more, and - Used for at least 30 days - Third UK resident test They work full-time in the UK 15
7. Residency and Domicile Residence Sufficient ties test (tax resident): - A family tie - An accommodation tie - A work tie - A 90-day tie - A country tie The sufficient ties test is applied to those who are neither automatic UK residents nor automatic overseas residents. It works on a sliding basis dependant on how many days UK residence an individual has. 16
7. Residency and Domicile Residence UK resident: - Taxable on their worldwide income as it arises Does not have to be remitted to the UK to be taxable Overseas resident - Taxable on their UK income as it arises In general, non-uk residents are not entitled to personal allowances (neither the income tax allowance nor the annual exempt amount for capital gains). However, citizens of the European Economic Area and Commonwealth countries, and residents in the Isle of Man and the Channel Islands, are entitled to these allowances. 17
7. Residency and Domicile Domicile Relevant only for the taxation of foreign income and gains for income tax and capital gains purposes Important for determining liability to inheritance tax Domicile of origin: - Acquired from father or mother Domicile of choice: - Applies from age 16 - Leave country of domicile and settle in another country Deemed domicile Her Majesty s Revenue and Customs (HMRC) may deem a person domicile if: They were domiciled in the UK during the three years before the transfer of assets They were considered UK resident for 17 out of the 20 tax years prior to the transfer of assets 18
7. Residency and Domicile UK Resident but non-domicile Can elect for overseas income and gains to be taxed by HMRC on a remittance basis - May incur a remittance basis charge for long-term residents 7 out of 9 years = 30,000 12 out of 14 years = 50,000 Remittance basis Most UK residents pay tax on an arising basis (i.e. as the liability arises). It is possible for non-domiciled residents to elect for taxation on a remittance basis. In doing so non-uk income and gains will not be subject to UK tax unless it is remitted to the UK. If you are resident and domiciled in the UK, but not tax resident, you can only use the remittance basis for foreign income. Gains will be taxed on an arising basis. Rules Unremitted income or gains below 2,000 use of remittance basis without claiming. Unremitted income or gains above 2,000 use of remittance basis by claiming through the self-assessment form. Personal allowance for income tax and annual exemption for CGT will be lost. Unremitted income above 2,000 and resident in the UK for seven out of nine consecutive tax years in addition to the above a remittance basis charge (RBC) must be paid currently 30,000. Note: there is no requirement to opt for remittance basis. New For those non-domicile that have been resident for 12 of the last 14 years are now subject to a RBC of 60,000, and if they have been resident for 17 out of the last 20 years, then a RBC of 90,000 applies. This is not reflected in the CISI workbook and will not be tested. 19
1. Income Tax Taxable income Non-savings income: - Income from employment, pensions and some social security benefits - Profits from a trade, profession or vocation, including profits from a partnership - Profits from a property business, e.g. rental income from a buy-to-let flat Savings income: - Interest from bank, building societies, bond interest (including gilts) and debentures - Income portion of a purchased life annuity - Income may have been received gross or net of income tax 20
1. Income Tax Taxable income UK dividend income: - Deemed to be received net of 10% tax credit Tax credit is deductible against the individual s tax liability Dividends are effectively tax-free for basic rate taxpayers - A company pays 900 in dividends: The shareholder will receive 900 An individual will declare 100 / 90 x 900 = 1,000 on their tax return 21
1. Income Tax Self-assessment Most individuals pay tax via the PAYE system (pay as you earn) Some individuals are required to complete a self-assessment tax return: - Self-employed - Individuals with capital gains in the year - Higher rate taxpayers with other income, such as rental income or savings or dividend income Self-assessment tax return deadline for 2015/16-31 January 2017 if submitted online - 31 October 2016 for a paper return submission - Payment of tax is due by 31 January 2017 Payment on Account For those taxpayers who are self-employed or who pay less than 80% of last year s income tax at source. The taxpayer will pay two equal payments on account of their tax on 31 January in the tax year and 31 July following the end of the tax year. These are payments to cover tax over the current year and are designed to improve HMRC s cash flow. There is a final sweep up, known as a balancing payment on the following 31 January based on the submitted tax return. 22
1. Income Tax Rates Allowances and deductions Personal allowance 2015/16 2014/15 Hints Interest income from bank accounts and building society accounts are assumed to have been received net of 20% tax. Dividend income on UK shares is deemed to have been received net of a 10% tax credit. Personal allowance 10,600 10,000 Age allowance: - Those born before 6th April 1938 receive a personal allowance of 10,660 This will be removed at a rate of 1 for every 2 earned above 27,700 The allowance is reduced to the standard allowance Additional tax implications for high earners Reduction in personal allowance for those earning over 100,000: - Personal allowance will be reduced by 1 for every 2 earned above a threshold of 100,000 - Personal allowance could be reduced to nil Further allowances may be available for married couples born before 1935. A blind person s allowance of 2,290 also exists ( 2,230 in 2014/15). 23
1. Income Tax Rates Overview Rates of tax on taxable income (after allowances): Additional rate Higher rate Basic rate Taxable income over 150,000 Taxable income between 31,786-150,000 Taxable income up-to-and-including 31,785 ( 31,865 in 2014/15) Starting rate for savings - 0% for the first 5,000 of interest income Non-savings income % Savings income % Dividends % 45 45 37.5 40 40 32.5 20 20 10 Use of Allowances If one spouse is a higher rate taxpayer and the other spouse is having a career break, it makes sense to transfer ownership of investments, that generate taxable income into the name of the non-working spouse. However, when income generated from capital, gifted by a parent to a child under 18, exceeds 100 pa all of the income will be taxed as if it is still the parent s own income. Hints Income tax is a marginal method of taxation. Different parts of your income are taxed at different rates. Additional rate 150,000 Higher rate 31,785 Basic rate Starting rate (Savings only) 5,000 Personal allowance: 10,600 24
Example Martin is 45 years old and has a salary of 60,000. What is the income tax liability on this income? Salary Personal allowance Taxable income Basic rate of tax Higher rate of tax Total income tax Tax 25
Keeping on target Solution Martin is 45 years old and has a salary of 60,000. What is the income tax liability on this income? What would the tax implications be on Martin if he received interest income from his bank account of 800 and dividend income from UK shares of 500? Tax Salary 60,000 Personal allowance ( 10,600) Taxable income 49,400 Basic rate of tax 31,785 @ 20% 6,357 Higher rate of tax 17,615 @ 40% 7,046 Total income tax 13,403 26
4. National Insurance Contributions (NICs) Who pays National Insurance? Employees: pay class 1 (primary) NICs Employers: pay class 1 (secondary) NICs, must keep NI records The self-employed class 2 ( 2.80 pw) - Small profits threshold The self-employed class 4 (variable on profits) Hints There is a short cut to calculating further tax for a higher rate taxpayer on net dividends and net interest. The short cut is simply multiply the net amount by 25%. For the question on the previous page, you could simply have done the following: 800 net interest + 500 net dividend = 1,300 net income Further tax to pay = 1,300 @ 25% = 325 Voluntary NI contributions Class 3 contributions are voluntary contributions to top-up benefits ( 14.10 pw) - Self employed can pay class 2 voluntary contributions instead Employees can earn up to 155 a week before paying class 1 primary NICs (primary threshold). However, as long as earnings are at least 112 a week, it is possible to build entitlement to the state pension (lower earnings limit). Self employed people with profits below 5,965 (small profits threshold) do not have to pay class 2 NICs. Class 4 NICs only apply if self employed people make profits of at least 8,060. Answer to the question on the previous slide Tax on interest income Gross interest = 800 x 100 / 80 = 1,000 Total tax = 1,000 @ 40% = 400 Further tax to pay = 400-200 = 200 Tax on dividend income Gross dividend = 500 x 100 / 90 = 555.56 Total tax = 555.56 @ 32.5% = 180.56 Further tax to pay = 180.56-55.56 = 125 27
5. Capital Gains Tax Capital gains tax Background to capital gains tax - Chargeable disposal Selling/Gifting/Transferring - Of a chargeable asset I.e. equity and holiday homes - By a chargeable person UK resident/ordinarily resident - Capital gains netted against allowable losses - Annual CGT exemption 2015/16 11,100 - CGT rates 18% (BRT) 28% (HRT & ART) Strategies to mitigate Capital Gains Tax Spreading ownership of assets between family members to make use of the maximum number of annual exemptions Phasing encashments over several tax years if at all possible in order to access more than one annual exemption Deliberately realising paper losses in order to reduce gains Keeping on target Mr. Boyle's overall gains in 2015/16 are 60,000 and he has other taxable income of 40,000. What is his capital gains tax liability? A. 16,800 B. 13,720 C. 13,692 D. 5,230 Keeping on target Marion has a taxable income of 30,000. She also makes a chargeable gain of 7,000. What CGT is due? 28
5. Capital Gains Tax Capital gains tax Allowable deductions from the gain: - Cost of the asset - Incidental costs of purchase and sale - Capital expenditure Note: costs incurred maintaining the asset are not allowable Exemptions: - Main home - Gilts and qualifying bonds - Venture capital trusts (VCTs) - Enterprise investment schemes (EISs) if held for three years - Assets in an individual savings account (ISA) Note: charities and most funds do not pay tax on capital gains Use of losses Step 1 net off any gains against any losses realised in the same year. If there is still a gain Step 2 use the annual exemption to reduce gains. If there is still a gain Step 3 use any losses carried forward from previous years (loss relief) to reduce gains further. What is left is a chargeable gain. Answer to the first question on the previous slide: B: 13,692 Chargeable gains 60,000 Annual exemption ( 11,100) Taxable amount 48,900 Tax @ 28% 13,692 Answer to the second question on the previous slide CGT uses the income tax bands to assess the CGT to charge. Marion only has 1,785 of her basic rate band remaining; any gain above that will be taxed at the higher rate. CGT at the basic rate = 1,785 @ 18% = 321.3 CGT at the higher rate = 5,215 @ 28% = 1,460.2 Total CGT = 1,781.5 29
8.1 Individual Savings Accounts (ISAs) ISA Up to 15,240 per tax year (allocate to cash and/or stocks and shares) Minimum age 16 years (cash ISA) UK resident ISA transfers Moving abroad Investments (minimum age 18 years for non-cash investments): - Cash - Shares (RIEs and AIM) - Bonds and gilts - Unit trusts/its/oeics/reits Child trust funds Contributions Contributions of up to 4,080 pa can be made by anyone Only accessible when child reaches age 18 Fund choice Cash based or investment fund based Ethical and Sharia a based funds available Junior ISA Junior ISA (JISA) replaced CTFs. These carry the same restrictions as a CTF. Existing CTFs can continue until the holder is 18 years of age. From April 2015, it is possible to transfer CTFs into a JISA. The information on ISAs, JISAs and CTFs can be found in Section 8 of chapter 5 in the CISI manual. 30
6.1 Inheritance Tax Inheritance tax Overview - A tax on wealth transfer, paid by the receiver - Applicable on death and also during certain lifetime transfers - Based on domicile (permanent home acquired from father or mother) UK domiciled individuals worldwide assets Non-UK domiciled UK assets - Nil rate band 325,000 at 0%, balance at 40% or 20% Potentially exempt transfers (PET) - Applicable on most gifts before death - If the transferor survives seven years it is exempt Chargeable lifetime transfers (CLT) - A transfer to a discretionary trust is a CLT Taxed at 20% Further tax may be due if donor dies within seven years 31
6.1 Inheritance Tax Exempt transfers Small gifts exemption - Gifts of 250 or less per donee (does not apply in trusts) Annual exemption - First 3,000 each tax year is exempt cannot use with 250, carried forward one year Normal expenditure out of income - E.g. maintenance of children at university Gift in contemplation of marriage or civil partnerships - 5,000 parent, 2,500 grandparent, 1,000 other (limit per donor) Between spouses - Exempt if recipient is domiciled in the UK Political party - At least two MPs elected; or one MP who attained at least 150,000 votes Housing Association and National Purposes AIM shares - Two year rule Transfers to UK registered charities are IHT exempt. Individuals who leave 10% of their estate to a registered charity may pay a lower IHT rate of 36%, instead of 40%. 32
6.1 Inheritance Tax Transferring the nil rate band Under new rules introduced from April 2008, it is now possible for married couples and civil partners to transfer the unused percentage of their nil rate band to their spouse. Example: - Mr X dies in tax year 2015/16. He leaves 100% of his nil rate band of 325,000 unused to his spouse. - Mrs X dies in 2018 when the nil rate band has, let s say, risen to 500,000. Mrs X is entitled to two nil rate bands, i.e. her own and her husband s The total nil rate band in this case will be 1,000,000 (not 650,000) Hints It is the percentage of the nil rate band that is passed on to the surviving spouse, not the monetary value. Keeping on target Barry dies in August 2014, with an estate worth 800,000. The majority of the estate is in his house worth 650,000. He is survived by May, his wife, and Sophia his daughter, to whom he left 100,000. In December 2015, May dies, leaving an estate of 625,000. The inheritance tax nil rate band for 2014/15 and 2015/16 is 325,000. What would be the inheritance tax liability upon Barry's death? 33
6.1 Inheritance Tax Gifts with reservation Reservation of benefit - Donor is still able to use the asset for free - Giving away a house, but still living in it - Such gifts are added back into the estate Pre-owned Asset Tax (POAT): - Applies to gifts with reservation (value in excess of 5,000 per annum) - A choice between POAT or IHT Keeping on target A father gives his daughter a property valued at 300,000 at the time of the gift. However, the father reserves total benefit and remains living in the property. Seven years later the father dies. The property is now valued at 280,000. What value, if any, will be added to the father s estate for IHT purposes? Valuations What values are used for IHT? The open market value (at the transfer). Quoted securities the lower of: - The value on a quarter up basis; and - The average of the highest and lowest marked bargains for the day Unit trusts bid price Life policies includes proceeds of policy Answer to the question on the previous slide: 0 As Barry died leaving a surviving spouse, any transfers between them are exempt from inheritance tax. The only amount that could be subject to inheritance tax is the 100,000 left to Sophia, but this is covered by the nil rate band exemption. Therefore, there is no inheritance tax liability upon Barry s death. 34
6.3 Intestacy Rules Wills A will specifies: - How you want your assets to be distributed - Who you want to be responsible for your children - Who you want to benefit from your estate Must have capacity to contract National intestacy rules If someone dies with a valid will (died testate) - Executors grant of probate If there is no valid will (died intestate) - Administrators letter of administration (died intestate) - Letters of administration cum testamento annexo (with the invalid will annexed) Deeds of variation When an individual inherits, but wants to change the terms due to tax reasons or to gain a fairer distribution of assets. Rules: Relates to a valid will, or an intestate estate Be signed by all parties who would have benefited; over 18; sound mind Be executed within two years of death of the legator (who left the money) No financial inducement/consideration to sign Answer to the question on the previous slide: 280,000 The gift was given with reservation, so the father never ceased to benefit. For this reason, the property is added back to the father s estate at the value on death. 35
6.3 Intestacy Rules Hints Common law spouses are not recognised by intestacy rules. Intestate how is the estate distributed? Married and civil partners: - No surviving direct relatives Inherit total wealth - No surviving children but surviving parents and siblings Inherits first 450K Inherits 50% of the remainder The other 50% shared equally among parents and siblings - Surviving children, grandchildren or great grandchildren Inherits the first 250,000 Plus ½ the remaining sum + chattels (children receive the balance) 36
6.3 Intestacy Rules Children - If there is a surviving spouse, the child/children only inherit if the estate is above 250k - Half the value of the estate above 250k Order of priority for remoter relatives from the deceased - Parents, brothers/sisters, nephews/nieces, etc. Who cannot inherit - Unmarried partners, close friends, carers 37
2. Taxation of Trusts What is a trust? A trust is a legal arrangement where assets are held (by the trustees) for someone else (the beneficiaries) Jargon: - Settlor Sets up the trust - Trustee Complies with terms of the trust To take control of trust property Duty of care - Beneficiaries Absolute vested interest Life interest Remainderman (reversionary interest) 38
2. Taxation of Trusts General tax treatment Who pays the tax? - In most cases the CGT/income tax falls upon the trustee, unless the beneficiaries include: The settlor Settlor s spouse or civil partner; or Settlor s minor children or step-children - In these cases, the tax liability falls on the settlor When the tax liability falls on the trustee: - Trustees can pay the CGT/income tax due from trust assets - Trusts gains are taxed at 28% - Can claim entrepreneurs relief up to a lifetime limit of 10 million Taxed at 10% - Trust CGT exemption is half the individual exemption i.e. 5,550 per tax year The standard CGT exemption of 11,100 exists for trusts where the beneficiary is disabled Types of trust Bare trusts or absolute trust Beneficiary has full access to trust income and capital Trustee obeys instructions of beneficiaries Trustee is a nominee only Discretionary trust Powers of appointment over trust assets Absolute discretion for trustee to distribute income to beneficiaries Interest in possession (life interest trust) Life tenant income from the trust Remainderman receives capital when life interest ends Accumulation and maintenance trust Allowed property to accumulate until beneficiary was 25 Permitted income to be used to fund maintenance of beneficiary 39
2. Taxation of Trusts Interest in possession trusts Trustee - The trustee will be charged tax on any income at the basic rate Life interest - The life interest is entitled to the trust income so they are liable for the tax - They are taxed on this income whether it is paid out or re-invested - The income is received net of basic rate tax (reclaim or pay extra tax) Discretionary/Accumulation and maintenance trusts Trustees - First 1,000 BRT 20% rental income and savings, 10% dividends - Above 1,000 ART 45% rental income and savings, 37.5% dividends Beneficiaries - Only liable if income is paid out - Amounts received are net of tax and could be reclaimed where necessary Bare or absolute trusts The trust is ignored and the tax falls upon the beneficiary at their own rates 40
Other considerations Parental settlements: - Relates to parents that settle funds for their children - The 100 income rule If the funds placed on account earn over 100 pa, the funds are assessed using their tax position Trusts for the vulnerable: - Can elect to be taxed on the beneficiaries to utilise their own allowances/ rates Personal representative of a deceased person: - The personal representative is liable for the settlement of: Any outstanding tax liabilities (at the rate originally charged) Any liabilities that arise over the administration period (basic rate) The term vulnerable is defined as a beneficiary who is either disabled or a relevant minor. A disabled person would be unable to manage their affairs due to mental disorder, or is someone who is in receipt of an attendance or disability living allowance. A relevant minor would be under the age of 18, and predeceased by at least one parent. 41
1.3 Taxation of Charities HMRC registration is required for UK charities to qualify for tax deductions Investment income and gains used for charitable purposes are tax exempt Election to receive bank interest gross of tax Tax relief on donations from UK taxpayers (gift aid scheme) No need to pay stamp duty land tax on property purchases May need to register for VAT If charities trade in the provision of goods and services, they may be required to pay tax on profits. If the income from trading exceeds 82,000 they will need to register for VAT and account for VAT in the usual way 42
8.1 Stamp Duty and Stamp Duty Reserve Tax Stamp duty and SDRT Taxes paid on the purchase of certain securities (UK incorporated companies) - Stamp duty payable paper transfer (0.5% round up to the next 5 for transactions above 1,000) - Stamp duty reserve tax payable electronic (0.5% round up or down 1p) - Gifts are exempt (no purchase) Investments - Shares/Share options 0.5% of the purchase value - Units in unit trusts not on units, but SD/SDRT on the underlying purchases - Government and corporate bonds no SD/SDRT unless convertible bonds Keeping on target Pete Smith purchases 400 shares worth 3 each. The settlement requires a stock transfer form. He also purchases 200 shares worth 2.50 each. The settlement takes place in CREST. Calculate the amount of tax payable on purchase. A. 2.50 B. 6 C. 8.50 D. 12.50 43
8.2 Stamp Duty Land Tax Stamp duty land tax Paid by the buyer only on purchase of land and property Residential values Residential SDLT Commercial values Commercial SDLT Up to 125,000 Zero < 150k < 1k annual rent Zero On the next 125k ( 125k to 250k) 2% < 150k > 1k annual rent 1% On the next 675k ( 250k to 925k) 5% 150k to 250k 1% On the next 575k ( 925k to 1.5m) 10% 250k to 500k 3% Remainder above 1.5m 12% Over 500k 4% 500k and above (when purchased by corporate bodies) 15% Dual purpose property Where the property has a dual purpose, HMRC will split the values and apply SDLT separately. Take a 300,000 shop, where 60% is deemed commercial and 40% a residential flat above the shop. For SDLT purposes the following would occur: Residential property 120,000 (40%) Commercial property 180,000 (60%) SDLT: 120,000 x 0% = 0 SDLT: 180,000 x 1% = 1,800 Answer to the question on the previous slide = D Paper shares stamp duty = 400 * 3 * 0.5% = 6, rounded up to 10. Electronic shares SDRT = 200 * 2.50 *0.5% = 2.50. Total stamp duty payable = 10 + 2.50 = 12.50. 44
9. Value Added Tax (VAT) What is VAT? A sales tax businesses add VAT to the price of their goods/services - Collecting the VAT for HMRC Which firms must register for VAT? - A firm with a turnover above the VAT threshold of 82,000 per 12 months Keeping on target Which of the following is not a current rate of VAT? A. 20% B. 10% C. 5% D. 0% Exempt goods and services - Insurance, providing credit, education, charity fundraising, doctors and dentists, selling/leasing/letting commercial land and buildings, statutory fees e.g. MoT, congestion charges etc. Charging and reclaiming VAT - Firms charge VAT (standard 20%, reduced 5%, or zero 0%) - Registered firms reclaim (offset) the VAT they pay for goods and services 45
10. Corporation Tax Overview of corporation tax Tax on companies - Does not apply to the self-employed sole traders and partnerships - Based upon the profits chargeable to corporation tax Other considerations - Capital allowances Tax allowance on capital spending reduces the tax due - Franked income Companies holding shares in other companies Corporation tax rate - 20% on all profits Hints The existence of a small profits and main rate for corporation tax has been removed. A single rate now exists for all profits. Double tax treaties Withholding tax Tax taken by the country from which payment was made Double tax relief To ensure tax is only taken once (earnings and investment income) Tax relief on the UK liability is based on the lower of the two taxes European Union Savings Directive (EUSD) Allows the transfer of information between tax authorities in the member states of the European Union Qualified intermediaries regime Allows brokers to pool the liabilities of non-us investors Protects the details of investors Answer to the question on the previous slide: B: 10% 46