Chapter 6: Taxation of Individuals

Question 1

Introduction

Answer 1

The taxes covered on the BLP module are:

• Income Tax;
• Capital Gains Tax (‘CGT’);
• Value Added Tax (‘VAT’); and
• Corporation Tax.

Of these, income tax, CGT, and corporation tax are examples of direct taxes whilst VAT is an example of an indirect tax.

Question 2

Direct Taxes

Answer 2

Direct taxes are imposed by reference to a taxpayer’s circumstances. For example, CGT is assessed by reference to an individual’s chargeable gains calculated on the basis of that individual’s circumstances. By contrast, indirect taxes are imposed by reference to transactions eg VAT is chargeable by reference to the value of supplies of goods or services provided. Inheritance Tax is only covered to a limited amount and Stamp Duty Land Tax is not covered in this module as you will learn more about these taxes in other modules.

Question 3

The distinction between income and capital

Answer 3

Whilst the difference between a receipt and an expense appears obvious, the distinction can be confusing in practice especially when dealing with the various types of each. A receipt is money (of whatever nature) that is paid TO the business and is often referred to as income. Contrast that to an expense which is money the business pays OUT.

Question 4

The distinction between income and capital

Answer 4

It is necessary to distinguish income receipts from capital receipts and income expenditure from capital expenditure. The reason for this is that, in general, income expenditure can only be deducted from income receipts and capital expenditure can only be deducted from capital receipts to reduce the overall tax bill (but see the corporation tax element regarding capital allowances for relief available in some circumstances).

Question 5

No statutory definition

Answer 5

There is no statutory definition of income or capital, but a series of general guidelines have been established by case law, which are summarised in this element. In practice, it can sometimes be difficult to distinguish between income and capital and you may come across scenarios where it is not clear into which category a particular receipt or expense falls.

It is important to be able to distinguish between income and capital to ensure that the correct tax treatment is applied. This will be explained in more detail later in the element.

Question 6

Income Receipts

Answer 6

Income receipts

Money received on a regular basis will be classified as an income receipt. For example:

• the trading profits of any business/profession will be income (this is synonymous to the salary received by an individual employee);
• interest the bank pays in relation to savings held in an account is an income receipt for the individual/business, and
• rent received by a landlord is an income receipt of the landlord.

Question 7

Capital Receipts

Answer 7

If a receipt is from a transaction that is not a part of such regular activity this is likely to be classified as a capital receipt. Think of capital transactions as ‘one-off’ transactions.

Therefore, if a newsagent’s business owned the premises from which the business operates then any gain on the sale of those premises would be a capital receipt.

Question 8

Expenditure

Answer 8

Having determined whether receipts are of an income or capital nature, it is also necessary to decide whether expenditure is of an income or capital nature.

Question 9

Income Expenditure

Answer 9

Money spent as part of day-to-day trading, is ‘income’ expenditure.

Bills for heating and lighting, rent, marketing and stationery expenses, staff wages and other fees in the general running of a business will be income expenses. General repairs will also amount to income expenses. Interest payable on loans is also expenditure of an income nature as it will be paid to the lender on a regular basis (whether that is monthly or quarterly) over a period of time.

Question 10

Capital Expenditure

Answer 10

If money is expended to purchase a capital asset as part of the infrastructure of the business or as an enduring benefit for the business, it is ‘capital’ expenditure.

As with capital receipts, capital expenditure can be seen as a ‘one-off’ transaction. Expenditure on large items of equipment and machinery or property will be capital expenditure.

Equally expenditure on enhancing a capital asset (other than routine maintenance) will be capital expenditure. Even though these assets are used by a business to trade, they are one-off purchases.

It is necessary to make the distinction between income and capital expenditure because certain INCOME expenditure can be set off against INCOME receipts in a business context to reduce the overall tax bill.

Question 11

INCOME RECEIPTS – LESS – INCOME EXPENDITURE = TRADING PROFITS

Example: deduction of INCOME expenditure from income receipts

Answer 11

A man runs an antique shop. He calculates all his income receipts from his trading activities so that he can then set off against (ie deduct from) these income receipts the income expenses he has incurred in the course of trading. Examples of such deductible income expenses are the cost of buying his stock and the lighting, heating and insurance for his shop. Accordingly, his tax bill is reduced because his income receipts (ie the amount in respect of which he is taxed) are reduced by his income expenditure.

Question 12

In general, relief for CAPITAL expenditure can only be deducted for tax purposes from the proceeds realised when a CAPITAL asset is disposed of.

Example: deduction of CAPITAL expenditure from CAPITAL receipts

Answer 12

The initial cost of an individual’s capital assets, for instance the cost of buying a shop and the van used to collect and deliver stock, cannot be set off against income receipts in order to reduce the individual’s tax bill. If, however, the shop or van was subsequently sold at a gain/profit (a capital receipt), for tax purposes it would be possible to reduce the gain/profit made on the sale of the asset by deducting the original cost of the asset (capital expenditure).

NB. a proportion of the cost of some capital assets (capital expenditure) can be set off against the trading profits (income receipts) of the business each year during the life of the asset concerned

Question 13

Capital Allowances

Answer 13

Tax relief (deductions from the tax bill) for capital expenditure is usually only given at the time when the capital asset is sold or otherwise disposed of (eg by way of gift).

Most of us are familiar with the concept of depreciation. We know the new car we buy (a capital asset) will depreciate in value over time. Depreciation is an accounting concept, whereby the cost of an asset is deducted in the accounts over a period of time. Depreciation is used here simply to illustrate the concept of capital allowances used in tax calculations as the tax equivalent of depreciation is capital allowances.

Question 14

Capital allowances spread the cost of capital expenditure

Answer 14

Capital allowances spread the cost of capital expenditure on certain capital items over a period of time. This is achieved by a proportion of the capital expenditure being deducted from income receipts over a period of time. Note that as an exception to the general rule you read about above (capital receipts less capital expenditure), capital allowances enable certain types of capital expenditure to be deducted from income receipts.

You will learn more about these in the Corporation Tax element. The relevant allowances are deducted when calculating trading profits (ie income) for tax purposes.

Question 15

Assessment of Tax

Answer 15

In general, there is a separate system for the administration of each particular tax which will be addressed in the relevant section of this topic.

It is important to note that the tax year (for individuals) and the financial year (for companies) are different to the calendar year.

HMRC collects tax from individuals and businesses (including sole traders, partnerships and companies) via the self-assessment system.

Question 16

Corporation Tax

Answer 16

Companies pay corporation tax on all income profits and chargeable gains that arise in each accounting period (this will be explained further in the corporation tax element).

Individuals are assessed to income tax and capital gains tax on the basis of a tax year which runs from 6 April in one calendar year to 5 April in the next.

Companies are assessed to corporation tax on the basis of a financial year which runs from 1 April in one calendar year to 31 March in the next.

Question 17

PAYE System

Answer 17

It is also important for you to be aware that in some cases income tax is deducted at source. This is the system whereby the payer of a sum that is taxable in the hands of the recipient deducts the tax due in respect of the sum and accounts for it to HMRC on the recipient’s behalf.

The recipient of the taxable sum therefore receives the sum net of tax (ie after tax has been deducted).

Question 18

PAYE System

Answer 18

One example of a sum where tax is deducted at source by the payer is the Pay As You Earn (PAYE) system. The employer deducts the income tax payable by the employee from the employee’s wage or salary, and accounts for this tax to HMRC. The employee receives the wage or salary net of income tax.

In calculating tax liabilities, it is important to note where tax has been deducted at source because it is the the gross amount of the receipt that must be included in the calculation (rather than the net amount).

Question 19

Glossary

Answer 19

You will come across the following terminology in this topic:

Annual exemption: For CGT: A tax allowance for individuals only.

Annual investment allowance: A special type of capital allowance.

Available tax reliefs: Certain payments which reduce an individual taxpayer’s Total Income eg interest on certain loans and pension contributions (relevant for income tax only).

Business Asset Disposal Relief: A tax relief available to individuals in certain circumstances to reduce their chargeable gains. It was formally known as “Entrepreneurs’ Relief” or “ER”.

Capital allowances: Tax allowances (ie deductions) for capital expenditure available to businesses (whether run by individuals or companies).

Question 20

Glossary

Answer 20

Capital gains tax (CGT): A tax paid by individuals on their taxable chargeable gains.

Corporation tax: A tax paid by companies on their taxable total profit (TTP).

Current year basis: Income tax is charged on the current year basis. This means that income earned in this current year (from 6 April 2024 to 5 April 2025) will be taxed in, and according to, the rates applicable to the tax year 2024/25. (See definition of ‘Tax year’ below.)

Deduction of tax at source: In some circumstances the payer of certain sums is obliged to deduct tax when making a payment eg deductions of income tax by employers (the PAYE system).

Dividend allowance: A band of tax free dividend income available to individuals for income tax purposes.

Financial year: Companies are assessed to corporation tax by reference to financial years (rather than calendar years). The financial year begins on 1 April in one calendar year and ends on 31 March in the next calendar year. A company’s accounting period can differ from the financial year.

Question 21

Glossary

Answer 21

Gross sums and net sums: A gross sum is the total sum before tax is levied. A net sum is the amount left after tax has been paid/deducted.

HMRC: HM Revenue & Customs, the body responsible for collection of all UK taxes covered in this Topic.

Income tax: A tax paid by individuals on their Taxable Income.

Indexation allowance: A tax allowance (ie deduction) for indexation available to companies in calculating their chargeable (ie capital) gains. This allowance takes into account inflation based on the Retail Price Index (“RPI”), so that a company is not taxed on chargeable gains arising solely because of inflation. Indexation allowance was frozen on 31 December 2017 and cannot be claimed for any period commencing on or after 1 January 2018.

Investors’ Relief (IR): A tax relief available to individuals in certain circumstances to reduce their chargeable gains.

Question 22

Glossary

Answer 22

Net Income: Total Income less available tax relief.

Non-savings income: Income which is not savings or dividend income such as salary (relevant for income tax only).

Pay As You Earn (PAYE): The system under which income tax and employees’ national insurance contributions are deducted at source (ie by the employer) from payments of salary and other employment income to employees.

Personal allowance: A band of tax-free income for individuals (relevant for income tax only).

Personal savings allowance: A band of savings income available for basic and higher rate taxpayers which is taxed at the savings nil rate (relevant for income tax only).

Question 23

Glossary

Answer 23

Savings income: Income from savings, such as interest (relevant for income tax only).

Taxable income: Net Income less the personal allowance (relevant for income tax only).

Tax year: Individuals are assessed to tax by reference to tax years rather than calendar years. The tax year begins on 6 April in one year and ends on 5 April in the next year.

Total Income: A taxpayer’s gross income from all sources before any deductions (relevant for income tax only).

TTP: Taxable total profits, chargeable to corporation tax. The total of a company’s taxable income profits and chargeable gains.

Value Added Tax (VAT): A tax collected by registered businesses chargeable on supplies of goods and services.

Question 24

Summary

Answer 24

• Income vs capital: it is important to distinguish between income receipts and expenses and capital receipts and expenses so that the correct tax treatment can be applied and the correct amount of tax paid.
• Capital allowances: a regime that allows certain types of capital expenditure to be deducted when calculating income receipts, thereby reducing the taxpayer’s tax bill.
• Assessment of tax:
• individuals are assessed to tax by reference to the tax year; and
• companies are assessed to tax by reference to the financial year (companies can choose an accounting period that does not match the financial year but will still have to calculate tax due for each financial year).
• Deduction of tax at source: certain payments require the payer to deduct the tax (which would ordinarily be payable by the recipient) from the payment and account for the tax to HMRC on behalf of the recipient.

Question 25

Self-Assessment

Answer 25

This means it is up to the individual to calculate the tax bill and not HMRC. Not all individuals are required to complete a self-assessment tax return. For example, employed individuals with uncomplicated tax affairs are not required to complete a self-assessment tax return because their tax is collected via the PAYE (Pay As You Earn) system. Directors, high and additional rate tax payers and self-employed people are examples of individuals who are always required to complete a self-assessment tax return.

Question 26

Deduction at source

Answer 26

This system is used where the payer of a taxable sum is obliged to deduct tax and account for it to HMRC. The recipient of the taxable sum receives it 'net of tax'. One example is the PAYE system.

Question 27

Summary of Income Tax Calculations

Answer 27

In order to calculate an individual’s income tax liability correctly, the following formula should be followed: Step 1 Calculate Total Income Step 2 Deduct available tax reliefs (interest on qualifying loans and pension contributions) = Net Income Step 3 Deduct Personal Allowance (reduced by £1 for every £2 of net income above £100,000) = Taxable Income Step 4 Split the Taxable Income into Non-Savings, Savings and Dividend Income NB. Taxable Income less (Savings Income and Dividend Income) = Non-Savings Income

Question 28

Summary of Income Tax calculation

Answer 28

Step 5 Calculate whether the Personal Savings Allowance (PSA) is available (i.e. looking at the Taxable Income figure to see which income tax band it ends in) Step 6 Apply relevant tax rates Step 7 Add together the amounts of tax calculated at Step 6 = Total tax liability The personal tax computation You will now work through a simple personal tax computation for an individual taxpayer in a non-business context. In order to do this, there are three terms that you will need to become familiar with. These are: Total Income: A taxpayer’s gross income from all sources Net Income: Total Income less available tax reliefs

Question 29

Taxable Income

Answer 29

Taxable Income: Net Income less the personal allowance It is important when calculating income tax that the steps are undertaken in order so that the correct amount of tax is applied to the correct elements of a person’s income.

Question 30

Calculating the total income

Answer 30

Total Income is a taxpayer's total gross income from all sources. This means that we need to add together all the receipts from all the sources of income of that particular individual. Where income has been received by a taxpayer after deduction of tax at source (ie 'net of tax'), you will need to include the gross amount in the calculation of Total Income. The calculation for this is known as “grossing up” (you are not expected to do this on this module). You have already seen that tax is deducted at source from earnings through the PAYE system. Savings income and dividend income are received gross (ie with no deduction at source). There are some special rules and allowances which apply to these particular types of income, as follows.

Question 31

Savings

Answer 31

Interest received by the individual on savings is subject to income tax but some taxpayers will have the benefit of a personal savings allowance. Basic rate taxpayers are entitled to their first £1,000, and higher rate taxpayers are entitled to their first £500 of interest received on savings at the savings nil rate. This means that the first £1,000, or £500 respectively of interest received on savings is taxed at 0%. Additional rate taxpayers do not get the benefit of a personal savings allowance. Examples of how savings income is taxed are set out later in this element.

Question 32

Dividends

Answer 32

Companies pay dividends to shareholders out of profits that have already been charged to corporation tax. To take account of this (in part at least), a dividend allowance was introduced. The effect of this allowance is that no individual pays any tax on the first £500 of dividend income they receive (prior to 6 April 2024 the allowance was £1,000). The allowance is the same for all taxpayers, no matter how much non-dividend income they receive. As we will see when we apply the rates of tax, the tax rates for dividends are different to those applicable to other forms of income. There is a useful summary table of the tax rates in Step 4 below. Examples of how dividends are taxed are set out below in this topic.

Question 33

Benefits in kind

Answer 33

Many employees receive benefits in kind in addition to the salary they are paid in respect of their employment. Benefits in kind include health insurance, company cars and gym membership. Cash payments of salary (including bonuses) are subject to deduction of tax under PAYE. Benefits in kind are subject to income tax but are NOT subject to deduction of tax under PAYE. Instead, the employer must report the amount of the benefit to HMRC as well as to the employee. The employee then includes the benefit sums on their tax return if they complete one. Such benefits must be included in the individual’s Total Income. Note: There are some minor exemptions to the rules on benefits in kind and there are also specific types of income which are exempt, but the detail of this is beyond the scope of this topic.

Question 34

Step 2: Calculating Net Income

Answer 34

Once Total Income has been calculated the next stage of the income tax computation is to deduct available tax reliefs in order to establish the taxpayer’s Net Income. The only tax reliefs we look at in this topic are interest PAID on qualifying loans and pension scheme contributions.

Question 35

1. Interest paid on qualifying loans

Answer 35

This type of interest is not to be confused with interest received by the individual from a bank on savings held at the bank (considered previously under total income). This interest is the interest an individual must pay TO the bank as the cost of receiving certain qualifying loans from the bank. Interest on qualifying loans is a form of tax relief because it can be deducted from Total Income to reduce the amount of income subject to tax thereby reducing the tax bill.

Question 36

1. Interest paid on qualifying loans

Answer 36

The amount of the interest paid on these loans must be deducted from the taxpayer’s Total Income in order to determine the taxpayer’s Net Income. Qualifying loans include: - loans to buy an interest in a partnership; - loans to contribute capital or make a loan to a partnership; - loans to buy shares in (or make a loan to) a 'close' company (you will learn about these in more detail later); and - loans to buy shares in an employee-controlled company or invest in a co-operative.

Question 37

Pension Scheme Contributions

Answer 37

Many individuals pay contributions into a pension scheme, either a scheme set up by their employer (an occupational pension scheme) or a personal pension scheme. Such contributions have the benefit of relief from income tax, subject to certain limits. Relief on pension contributions is given as follows: An amount equivalent to the pension scheme contributions made by a taxpayer during the tax year are deducted from their Total Income for that year (ie at the same time as interest on qualifying loans).

Question 38

Pension Scheme Contributions

Answer 38

Note: There are limits to the amount an individual can pay into their pension scheme each year but this is beyond the scope of this topic. Most contributions made by an employer to an employee’s pension scheme will be exempt from income tax. Certain charitable donations are also eligible for tax relief.

Question 39

Example

Answer 39

Example A woman bought an interest in a catering business which is run as a partnership with two others. In order to do so, she took out a bank loan on which the annual interest payments are £3,000. The woman also paid £2,500 into her personal pension scheme. The woman’s annual income from the partnership for the 2024/25 tax year is £56,000.

Question 40

The woman’s Net Income would be calculated as follows:

Answer 40

Total income £56,000 (annual income) Less Tax reliefs: £3,000 (interest paid on bank loan – this is a "qualifying loan") £2,500 (pension contributions) Net Income: £50,500

Question 41

Step 3: Calculating Taxable Income Personal allowance taxed at 0%

Answer 41

Once Net Income has been calculated, the next stage of the income tax computation is to deduct the taxpayer's Personal Allowance in order to ascertain the taxpayer’s Taxable Income. The personal allowance for the tax year 2024/25 is £12,570. The amount of this allowance is reduced by £1 for every £2 of Net Income above £100,000. Going back to the woman in the example above, the next stage in her income tax computation would be: Net Income £50,500 Less Personal Allowance (£12,570) Taxable Income £37,930

Question 42

Reduced Personal Allowance

Answer 42

The personal allowance of £12,570 is reduced by £1 for every £2 of Net Income above £100,000. This means that individuals with Net Income of £125,140 and above will lose the benefit of the personal allowance completely. To work out the reduced allowance for individuals with Net Income between £100,001 and £125,000, follow this formula: £12,570 – [(Net Income - £100,000) / 2] = reduced allowance

Question 43

Example: application of personal allowance on earnings up to £100,000 but below £125,140: Amount of reduced allowance

Answer 43

Net Income £110,000 Less Personal Allowance Calculated by: £12,570 – [(£110,000 - £100,000) / 2] i.e. £12,570 – 5,000 = £7,570 (amount of reduced allowance) Taxable Income = £110,000 - £7,570 = £102,430

Question 44

Example: application of personal allowance on earnings above £125,140

Answer 44

Net Income £130,000 Less Personal Allowance (0)* Taxable Income £130,000 *£12,570 – [(£130,000 - £100,000) / 2] = a negative figure. In this scenario none of the personal allowance would be left so there is no deduction from Net Income.

Question 45

Step 4: Split the Taxable Income

Answer 45

It is CRITICAL that the different types of income (non-savings, savings and dividend) income are separated at this point as they MUST be taxed in the order of non-savings, then savings, and then dividend income as different tax rates apply to each type of income. It may be useful to remember a mnemonic in order to recall which order the incomes are taxed (examples include: “never squash donuts” or “never say die”).

Question 46

Step 4: Split the Taxable Income

Answer 46

In order to calculate non-savings income, simply deduct the savings and dividend income figures from the Taxable Income. Taxable Income LESS Savings Income LESS Dividend Income = Non-Savings Income Worked examples appear under the tax rate summary table.Step 4: Split the Taxable Income

Question 47

Tax Rate Summary Table 2024/25 (post 6 April 2024)Tax band > taxable income > Non-savings > Savings* > Dividends**

Answer 47

Basic > 0 – 37,700 > 20% > 20% > 8.75% Higher > 37,701- 125,140 > 40% > 40% > 33.75% Additional > +125.140 > 45% > 45% > 39.35%

Question 48

Tax Rate Summary Table 2024/25 (post 6 April 2024)Tax band > taxable income > Non-savings > Savings* > Dividends**

Answer 48

*NB these savings rates are applied AFTER the personal savings allowance has been applied (see below). ** NB these dividend rates are applied AFTER the nil rate has been applied to the first £500 of dividend income. The nil rate applies to ALL individuals irrespective of the level of their taxable income. NB for the year 2023/24 the nil rate for dividend income applied to the first £1,000 of dividend income.

Question 49

STEP 5: The Personal Savings Allowance

Answer 49

Savings income is taxed at 0% (the savings nil rate) for the first £1,000 (if the taxpayer’s entire Taxable Income is within the basic rate band) or the first £500 (if the taxpayer’s entire Taxable Income exceeds the basic rate band but does not exceed the higher rate band, ie is not over £125,140). There is no savings nil rate for taxpayers whose Taxable Income exceeds the higher rate band (over £125,140).

Question 50

STEPS 6 and 7: Apply tax rates and add together tax - Worked Example Example 1

Answer 50

If we continue with the example of the woman above, since all of her £37,930 Taxable Income is non-savings income, the next stage of her income tax computation would be as follows: Taxable Income £37,930 Charge tax as follows: 20% on first £37,700 = £7,540 40% on balance of £230 =£92 Total tax payable = £7,632

Question 51

Example 1

Answer 51

You will see from the above example that the woman’s non-savings income crossed over / straddled the basic and higher rate bands. The non-savings income therefore had to be apportioned to the correct band. You ALWAYS use up the lower bands first, just as we did in the above example.

Question 52

Example 2: Factual Scenario A man receives a salary of £75,000, plus benefits in kind to a value of £450. He pays pension contributions of £3,000, and receives interest of £2,000 on his savings, and earns £2,500 by way of dividends on the shares he holds. Step 1

Answer 52

STEP 1: Calculate Total Income Salary: £75,000 Benefits: £450 Interest: £2,000 Dividends: £2,500 £79,950

Question 53

STEP 2: Calculate Net Income

Answer 53

£79,950 (Total Income) LESS £3,000 (pension contributions) = £76,950

Question 54

STEP 3: Calculate Taxable Income

Answer 54

£76,950 (Net Income) - £12,570 (personal allowance) = £64,380

Question 55

STEP 4: Split the Taxable Income

Answer 55

Separate the types of income: £64,380 (Taxable Income) LESS £2,500 (dividend income) LESS £2,000 (savings income) = £59,880 non-savings income.

Question 56

STEP 5: Apply the personal savings allowance (PSA)

Answer 56

As this man's taxable income is going to fall within the higher rate of tax, he is entitled to the first £500 of his savings income at the nil rate (0)%.

Question 57

STEP 6: Apply the relevant tax rates to Apply the tax rates to the types of income in the order of non-savings, then savings, then dividend income:

Answer 57

Non-savings income (£59,880): Basic rate band: £0 to £37,700 @ 20% = £7,540 Higher rate band: The balance of £22,180 (i.e. £59,880 – £37,700) will all be taxed at 40% as it all falls within the higher rate band £37,701 to £59,880 (i.e. £22,180) @ 40% = £8,872 Total tax on non-savings income = £16,412. (ie £7,540 + £8,872)

Question 58

Savings income (£2,000)

Answer 58

Apply the personal savings allowance. As this man is a higher rate taxpayer, he is entitled to the first £500 of his savings at 0%. Balance of £1,500 @ 40% (as all falling within the remainder of the higher rate band) = £600* Total tax on savings income = £600 *NB:** As non-savings income used up all of the basic rate band and there is sufficient capacity in the higher rate band for all of the savings income, savings income is taxed at the higher rate. IF there had been insufficient capacity in the higher rate band, the part of savings income that crossed the band into the additional rate would be taxed at the additional rate. This concept is explained in greater detail below (see the cake method).

Question 59

Dividend Income

Answer 59

Dividend income (£2,500) Apply the nil rate band to the first £500 as this is available to all taxpayers. The balance of £2000 will be taxed at 33.75% as there is sufficient capacity within the higher rate band (see tax summary table above for the applicable rates to be applied). £2000 @ 33.75% = £675 Total tax on dividend income = £675

Question 60

Total Tax Payable

Answer 60

Lastly, add the tax payable on the three types of income to obtain the taxpayer’s total tax liability. £16,412 (non-savings) + £600 (savings) + £675 (dividend) = £17,687 Total tax payable

Question 61

The Cake Method for the three types of tax

Answer 61

Another way to look at applying the different tax rates to the different bands of income in calculating income tax is to think about it in terms of baking a cake. You may wish to use this device to remember how to carry out the calculation. Think of each type of income as being a different layer of the cake - ie: 1) non-savings income is the base layer; 2) savings income is the cream filling; and 2) dividend income is the top layer.

Question 62

The Cake Method (Three Layers of Cake)

Answer 62

Think of the tax bands as measurements on a ruler sitting vertically next to the cake. The total taxable income will be the height that the overall cake will rise to. Each layer of the cake will rise according to how much tax the taxpayer must pay on each type of income. Each type of income sits on top of the one before (like the layers in a cake), with the effect that each tax bracket is used up in turn and no bracket is used until the one before it has been exhausted. If a layer of the cake/type of income rises through a tax band, then the tax rate to be applied will have to be apportioned accordingly (as we saw with the non-savings income in Example 2 above). Example 2 is then illustrated using the cake method but uses the same methodology and figures as set out in the worked example above.

Question 63

Income Tax Due for the year

Answer 63

At the end of the personal tax computation, we establish the total amount of tax that the individual taxpayer should pay for the year. If the taxpayer is in employment with little other income during the relevant tax year, then much of this tax will have been paid already through the PAYE system. The income tax that remains to be paid must be settled in each year by a final payment to HMRC. Alternatively, if the amount still outstanding and due to HMRC is fairly small, it may be recovered by HMRC through an adjustment to the individual’s PAYE tax code for the following tax year. If it transpires that the taxpayer has overpaid tax during the year the taxpayer will receive a tax refund from HMRC.

Question 64

National Insurance Contribution

Answer 64

Individuals also pay National Insurance Contributions (‘NICs’) out of employment income via the PAYE system. NICs do not affect the individual’s personal income tax computation in any way and will not be considered any further.

Question 65

Example 3: income tax due for the year (higher rate taxpayer)

Answer 65

NB. Steps 1, 2 and 3 have already been calculated so we pick this calculation up at Step 4. A man has the following income: Taxable Income £44,700 Made up as follows: Non-savings income £39,600 Savings income £5,000 Dividend income £100 As the man is a higher rate taxpayer, he will be entitled to a personal savings allowance of £500 of savings income at the savings nil rate.

Question 66

Charge tax as follows: Tax non-savings income first

Answer 66

20% on first £37,700 - Tax Due = £7,540 40% on (39,600-37,700) £1,900 - Tax Due - £760

Question 67

Then tax the savings income

Answer 67

0% on first £500 - Tax Due - £0 40% on (£5,000 - £500) £4,500 - Tax Due - £1,800

Question 68

Then tax the dividend income (covered by the dividend allowance)

Answer 68

0% on £100 - Tax Due - £0

Question 69

Total tax liability £10,100 (£7540 + £760 +£1,800)

Answer 69

If the man’s payslips show that £9,000 of income tax has been deducted from his salary under PAYE in this year, then his income tax due for the year is (10,100-9,000) £1,100.

Question 70

Summary of Income Tax Calculation

Answer 70

Step 1 Calculate Total Income Step 2 Deduct available tax reliefs (interest on qualifying loans and pension contributions) = Net Income Step 3 Deduct Personal Allowance (reduced by £1 for every £2 of net income above £100,000) = Taxable Income Step 4 Split the Taxable Income into non-savings, savings and dividend income NB. Taxable Income less (savings income and dividend income) = non-savings income

Question 71

Summary of Income Tax Calculation

Answer 71

Step 5 Calculate any personal savings allowance that is available (ie looking at the Taxable Income figure to see which income tax band it ends in) Step 6 Apply relevant tax rates Step 7 Add together the amounts of tax calculated at Step 6 = Total tax liability

Question 72

Anti-avoidance legislation

Answer 72

A certain amount of tax legislation has been developed by successive governments in order to put a stop to loopholes which have been exploited by taxpayers seeking to reduce or eliminate their tax liabilities. HMRC and the courts are increasingly hostile towards tax avoidance schemes.

Question 73

Anti-avoidance legislation

Answer 73

In relation to income tax, you should be aware that a taxpayer cannot reduce their income tax liability by making gifts of certain income-producing items eg shares (which give rise to dividends) or a lump sum (which gives rise to interest) to their children. Instead, under special legislation often referred to as the ‘settlements’ legislation the income is treated as remaining with the taxpayer who made the gift.

Question 74

Summary

Answer 74

- Income tax is charged at different tax rates. The rate to be applied will depend upon (i) the type of income and (ii) which band the income falls into (basic, higher or additional rate bands). - Individuals pay income tax on their salaries via the PAYE. - Any tax deducted at source (such as PAYE) has effectively already been paid and must be deducted from the tax liability before payment of the tax is made to HMRC.

Question 75

Summary

Answer 75

- Each individual is entitled to an annual Personal Allowance. The personal allowance is reduced by £1 for every £2 of net income above £100,000. If Net Income is £125,140 or above, none of the PA is available. - Some individuals have the benefit of the Personal Savings Allowance. For basic rate taxpayers, the first £1,000 of savings income is taxed at the savings nil rate and for higher rate taxpayers, the first £500 is taxed at the savings nil rate of 0% (in each case after the starting rate for savings has been applied, if applicable). - The first £500 of dividend income for all taxpayers is taxed at the dividend nil rate of 0%.

Question 76

Capital Gains Tax Introduction

Answer 76

The idea behind Capital Gains Tax (‘CGT’) is to tax the profit that a person might make from disposing of a capital asset which has appreciated (increased) in value during their period of ownership. CGT is charged where there is: * a Chargeable Disposal * of a Chargeable Asset * by a Chargeable Person * whichgives rise to a Chargeable Gain.

Question 77

Relevant Tax Year

Answer 77

CGT is charged on all gains made in therelevant tax year (i.e. 6 April to 5 April). The tax is payable on or before 31 January following the tax year in which the disposal occurs. This is the same date as for the final payment (or refund) of income tax for the year.

Question 78

Chargeable Disposal

Answer 78

The two main instances of disposal are as follows: the sale of an asset; and the gift of an asset during the tax payer’s lifetime. There is no chargeable disposal on death. The personal representatives of the deceased’s estate are deemed to acquire the estate at its then market value. This is commonly known as ‘a free uplift on death’.

Question 79

Chargeable Asset

Answer 79

All forms of property are included in the definition of asset unless they are specifically excluded. The main types of asset excluded from CGT are: Principal private residence (‘PPR’): an individual can claim the benefit of this exemption from CGT if they have occupied the PPR as their only or main residence during the whole period of ownership, though the individual also has a valuable exemption in respect of the last 9 months of ownership even if they were not in actual occupation. In cases where an individual owns more than one home it is a question of fact as to which of the residences is the PPR. A married couple can only have one PPR between them: they cannot each have a different principal place of residence (unless separated);

Question 80

Chargeable Asset

Answer 80

Motor cars for private use, including vintage cars; Certain investments, such as government securities, National Savings certificates, shares and securities held in Individual Savings Accounts (ISAs) and life assurance policies; and UK sterling and any foreign currency held for your own or your family’s personal use.

Question 81

Chargeable Gain

Answer 81

A gain needs to have been made when disposing of the asset and in calculating the chargeable gain, the starting point is always the consideration received (or deemed to have been received). The appropriate rate of CGT (either 20% or 10% unless it is an upper rate gain - see further below) is then applied to the chargeable gain. Disposals to charities are treated as made on a no gain/no loss basis. Gains made by charities are exempt provided that the gain is applied for charitable purposes.

Question 82

Disposals between Spouses

Answer 82

When one spouse disposes of an asset to the other, legislation deems that neither a gain nor a loss has occurred, so no CGT is payable. In effect, the spouse receiving the asset takes over the base cost (ie the original cost of the asset to the transferring spouse) of the spouse who disposed of it. This is the case for spouses or civil partners notwithstanding disposals between connected persons (see later).

Question 83

Example

Answer 83

A husband bought shares in a company for £4,000 in May 2020 and three years later gave the shares to his wife. For CGT purposes, there is no capital gain (or loss) on this ‘disposal’ by the husband: the wife in effect acquires the shares at a value of £4,000 with an acquisition date of May 2024.

Question 84

Consideration received

Answer 84

1. Disposals at arm’s length Where there is a sale ‘at arm’s length’, the consideration received will be the price paid by the buyer when the asset is sold. 2. Disposals between connected persons If the parties are connected persons, HMRC will deem the seller to have received market value irrespective of the actual sale proceeds.

Question 85

Example

Answer 85

A woman bought some shares in a computer company in 2003 for £5,000. She sells them to her daughter in April 2024 for the same price that she paid for them, £5,000. The market value of the shares at the time she sells them was £40,000. For CGT purposes, the woman is deemed to have disposed of the shares for £40,000 and will be liable to CGT accordingly. Her daughter is deemed to have acquired the shares in April 2024 for £40,000.

Question 86

‘Connected Persons’ include:

Answer 86

* The individual’s relatives and spouses of their relatives. Relatives are direct ancestors (parents and grandparents), lineal descendants and brothers and sisters but not ‘lateral’ relatives, eg uncles, aunts, nephews, nieces. * Companies, if they are under common control. * Partners in business. Remember that this does not include a disposal to an individual’s own spouse.

Question 87

Consideration Received

Answer 87

3. Disposals at an undervalue If the transaction is between unconnected persons and at an undervalue, then for CGT purposes, the sale is deemed to be at the market value at the date of disposal. Note, however, HMRC will not substitute market value if the seller has simply made a bad bargain. 4. Gifts Where a gift is made, the donor will be deemed to have received the market value of the asset at the date of the gift.

Question 88

Basic Calculation of the Gain

Answer 88

In order to calculate the chargeable gain made by the seller the following basic calculation must be followed: Consideration Received - Sale proceeds (or market value) = X Less: Allowable Expenditure (eg original purchase cost) – (X) = Gain

Question 89

Example

Answer 89

A man purchased a sailing boat to use on his holidays on the Isle of Wight for £100,000 in May 2019. He found that he did not enjoy sailing as much as he expected to and in May 2024 sold the boat for £130,000 The man’s gain on the sale is £30,000: Sale proceeds £130,000 Less: original purchase price (£100,000) Gain: £30,000

Question 90

Allowable Expenditure

Answer 90

There are three types of expenditure which can be deducted from the consideration (or deemed consideration) received. These deductions enable the taxpayer to minimise the gain made and therefore the tax payable. The categories of expenditure are as follows:

Question 91

Allowable Expenditure

Answer 91

Disposal expenditure Incidental costs of disposal (eg agents’ commission). Initial Expenditure The cost price of the asset (the ‘base cost’); and The incidental costs of acquisition (eg surveyors’ fees/lawyers’ fees). Subsequent expenditure Subsequent expenditure on the asset which enhances its value; and Expenditure incurred in establishing, preserving or defending title to the asset. Calculation of the gain to include all forms of allowable expenditure

Question 92

Calculation of Chargeable Gain by the Seller

Answer 92

In order to calculate the chargeable gain made by the seller all of the allowable expenditure needs to be included in the calculation as follows: Sale proceeds (or market value) Less disposal expenditure = Net sale proceeds Less initial expenditure Less subsequent expenditure = Chargeable gain

Question 93

Using capital losses

Answer 93

Instead of a capital gain, a loss may result from a disposal. Capital losses are created when the cost of an asset is greater than the consideration received for it on disposal (although a gift cannot be used to create a capital loss for these purposes). Since CGT is only charged on overall gains made by an individual in a tax year, any capital losses that an individual has made in the same tax year can be carried across and deducted from any gains made in that tax year. Such losses must be set off against other capital gains made in the same tax year first.

Question 94

Using Capital Losses

Answer 94

If there are insufficient gains against which to offset the losses in the same tax year that they are incurred, any unrelieved losses are set against gains in future tax years I.e. carried forward (in so far as the gains in those years are not covered by the annual exemption; see below) until used up. There is no time limit on taking a loss forward but it must be used against the first available gains. Note that there are limits as to how much an individual may claim in loss relief in certain circumstances (we will not explore this further).

Question 95

Annual Exemptions

Answer 95

Every individual is entitled to an annual exemption. The annual exemption for the current tax year is £3,000, it was £6,000 in the previous tax year. This means that all individuals are entitled to make up to £3,000 of gains tax free in this tax year. Companies do not have the benefit of any AE.

Question 96

Tax payable on the gain Company

Answer 96

When the Total Chargeable Gain (i.e. after deductions and the annual exemption) has been calculated, losses can then be taken into account and all gains are added together to find the Total Taxable Chargeable Gains. It is then necessary to calculate the tax payable on the total taxable chargeable gains. In order to calculate the tax payable, the following rules apply: 1. Companies All gains realised by companies will be calculated according to similar principles as those applying to CGT (with certain exceptions eg companies qualify for indexation allowance for inflationary gains up to December 2017 but do not have an annual exemption). Such gains will then be taxed at corporation tax rates (see later). Companies do not pay CGT; they pay corporation tax. Therefore, in relation to gains made by companies, reference should be made to ‘corporation tax on chargeable gains’ rather than CGT. Note: charities are generally exempt from paying CGT.

Question 97

Individuals

Answer 97

There are two rates of CGT: 10% and 20% (unless the gains are upper rate gains (see below)). Broadly, basic rate taxpayers pay 10% CGT and higher and additional rate taxpayers pay 20% CGT. It is important to have calculated a person’s income tax prior to their capital gains tax in order to establish this. The details of the calculation are as follows: * Where an individual’s Taxable Income plus total taxable chargeable gains after all allowable deductions (including losses and the AE) is less than the basic rate tax threshold of £37,700, the rate of CGT will be 10%. * Where an individual’s Taxable Income exceeds the basic rate tax threshold of £37,700, the CGT rate will be 20%.

Question 98

Individuals

Answer 98

* Where an individual’s Taxable Income is less than the basic rate tax band threshold of £37,700 but after the gains are added, the combined total exceeds the threshold that part of the gains within the unused part of the basic rate tax band will be charged to CGT at 10% and any part that exceeds the threshold will be charged at 20%. Apportioning tax in this way when bands are straddled was also seen in Example 2 of the income tax element. Note: Certain gains known as 'upper rate gains' are charged at 18% or 24%, for example disposal of a property that is not a PPR. We will not consider the details of upper rate gains.

Question 99

Summary of Capital Gains Tax calculation

Answer 99

In order to calculate an individual’s capital gains tax liability correctly the following formula should be used: Sale proceeds/market value: A Less disposal expenditure: (B) = Net Sale Proceeds: C Less initial expenditure: (D) Less subsequent expenditure: (E) = Total Chargeable Gain: F Less carried forward or carried-across losses: (G) Less annual exemption: (3,000) = Taxable Chargeable Gain: H Apply CGT to the Taxable Chargeable Gain (H) at the appropriate rate (10% or 20%)

Question 100

Business Asset Disposal Relief (formerly known as Entrepreneur’s Relief or ER)

Answer 100

Business Asset Disposal Relief reduces the higher rate of CGT from 20% to 10% for gains arising on qualifying disposals. The reduced 10% rate of CGT is applied to the Taxable Chargeable Gain (ie the gain after all allowable deductions, losses and the annual exemption).

Question 101

A qualifying disposal is a disposal of

Answer 101

all or part of a trading business; assets in a business that used to trade; shares in a trading company; or shares in a company that used to trade; where, in each case, certain conditions are satisfied. The conditions are as follows:

Question 102

A qualifying disposal is a disposal of:

Answer 102

1. Where someone disposes of all or part of a business: * the business must be a trading business; and * the business must have been owned for at least two years prior to the date of disposal. 2. Where someone disposes of assets used in a business that used to trade: * the business must have been owned for at least two years before it ceased to trade; * the assets must have been used in the business when it ceased to trade; and * the assets must have been disposed of within three years of the business ceasing to trade.

Question 103

A qualifying disposal is a disposal of:

Answer 103

3. Where someone disposes of shares in a company: * the company must be and have been for at least two years before to the date of disposal, a trading company; * the shares must have been held for at least two years before the date of disposal; * the person disposing of the shares must have been an officer or employee of the company who holds at least 5% of the ordinary voting shares and is entitled to at least 5% of the profits available for distribution and 5% of the net assets on a winding up, for at least two years before the date of disposal.

Question 104

A qualifying disposal is a disposal of

Answer 104

4. Where someone disposes of shares in a company that used to trade: * the shares must (generally) have been owned for at least two years before the company ceased to trade; * the person disposing of the shares must have been an officer or employee of the company who held at least 5% of the ordinary voting shares, and was entitled to at least 5% of the profits available for distribution and 5% of the net assets on a winding up, for at least two years before it ceased to trade; and * the shares must be disposed of within three years of the company ceasing to trade. Note that Business Asset Disposal Relief is not automatic: in order for it to apply, the taxpayer must make a claim on or before the first anniversary of 31 January following the tax year in which the relevant disposal is made.

Question 105

Business Asset Disposal Relief – Lifetime Allowance

Answer 105

Business Asset Disposal Relief gives each individual a lifetime allowance, which is now set at £1 million. This means that the first £1 million of qualifying gains that an individual makes in his lifetime can be charged to CGT at a reduced rate of 10%. An individual can make as many qualifying claims as they like during their lifetime until their cumulative gains reach the £1 million lifetime limit. Any gains beyond the £1 million lifetime allowance will be charged to CGT at either 10% or 20% (depending on the rate at which the individual pays CGT; see below).

Question 106

Example

Answer 106

If the Taxable Chargeable Gain (ie the gain after all allowable deductions, losses and the annual exemption) is £150,000 and Business Asset Disposal Relief applies, a rate of 10% CGT will be applied to that figure. So the calculation would be: Taxable Chargeable Gain = £150,000 CGT @ 10% = £15,000 You will see that the references throughout are to trading businesses and companies. Business Asset Disposal Relief is not available in respect of investment businesses or companies. This means that the disposal of a buy-to-let property investment or other non-trading business will not qualify for Business Asset Disposal Relief.

Question 107

Investors’ Relief (‘IR’)

Answer 107

IR was introduced to give a benefit to investors in unlisted trading companies who hold their shares for at least three years. IR reduces the higher rate of CGT from 20% to 10% for gains arising on disposals of qualifying shares, subject to a lifetime limit of £10 million. Shares will be qualifying shares if the following conditions are met: * The shares are fully paid ordinary shares and were issued to the individual for cash consideration on or after 17 March 2016; * The company is (and has been since the shares were issued) a trading company or the holding company of a trading group;

Question 108

Investors’ Relief (‘IR’)

Answer 108

* At the time of issue of the shares, none of the company’s shares were listed on a recognised stock exchange; * The shares are held by the individual for at least three years from 6 April 2016 (and continuously since issue); and * The individual (or any connected person) is not (nor at any time has been from the date of issue of the shares) an officer or employee of the company (or any connected company).

Question 109

Other Business Reliefs

Answer 109

Alongside BADR and IR, there are two main business reliefs, which defer liability to CGT. These are: · Replacement of business assets relief (‘Rollover Relief’) · Gift of business assets relief (‘Hold-over relief’) 1. Replacement of business assets relief (‘Rollover Relief’) To avoid having to pay CGT each time certain business assets are sold and replaced, a taxpayer can elect to postpone the CGT liability it realises on the sale of such an asset by ‘rolling over’ the gain into the replacement asset. ​ This applies to land and buildings, fixed plant and machinery and goodwill. The new asset need not necessarily be of the same type as the old one. It merely needs to be within the list of qualifying assets.

Question 110

Effect of the relief

Answer 110

The effect of the relief is that any gain arising from a disposal of a qualifying asset is carried forward and ‘rolled’ into the cost of a qualifying replacement asset. The acquisition cost of the replacement asset is reduced by the amount of the gain being rolled over. ​ Therefore, any tax relief is postponed until the replacement asset is sold and no new qualifying replacement asset is purchased in its place. ​ It is possible to roll over gains indefinitely provided sufficient qualifying assets are bought within the time limits. ​ The annual exemption cannot be used to reduce the gain rolled over.

Question 111

Gift of business asset relief

Answer 111

Where an individual gives away a business asset, the donor (the person making the gift) and donee (the person receiving the gift) can claim hold-over relief. As a transfer at an undervalue or gift, the market value rule will apply. The donor will have no liability to CGT but the donee’s acquisition cost for CGT purposes is reduced by the amount of the donor’s deemed gain. In effect the CGT liability is postponed until the donee ultimately disposes of the asset (although further hold-over relief can be claimed if the donee then gives away the asset).

Question 112

2. Gift of business assets relief (‘Hold-over relief’)

Answer 112

As in the case of roll-over relief, the whole chargeable gain must be held over if a claim for hold-over relief is made. The donor cannot use his annual exemption to reduce the gain held over. Hold-over relief may also be claimed where an asset is sold at undervalue but the hold-over relief will only be available on the gift element, ie the difference between the price paid and the market value. Business assets on which hold-over relief may be claimed include goodwill, assets used in the business and shares in a trading company not quoted on a stock market.

Question 113

Summary

Answer 113

* CGT is charged when there is a chargeable disposal of a chargeable asset by a chargeable person, which gives rise to a chargeable gain. * There are two main types of disposal: a gift and a sale of an asset. * The starting point for the CGT calculation is establishing the consideration or proceeds received by the seller on the disposal of the asset, subject to any substitution of market value if the transaction occurs between ‘connected persons’ or between unconnected persons and for an undervalue. * CGT is charged at 20% (for higher and additional rate taxpayers), 10% for basic rate taxpayers and 10% where the individual benefits from Business Asset Disposal Relief or Investors’ Relief. * There are several ways to mitigate the CGT liability, eg allowable expenditure, Business Asset Disposal Relief and Investors’ Relief (provided the conditions are fulfilled), losses; and each individual is entitled to an annual exemption.

Question 114

Inheritance tax and the Business Exemption relief Introduction Chargeable Transfers - Revisionf

Answer 114

A PET is a transfer of value made by a person during their lifetime (inter vivos) to another individual, eg a parent who gives their child a £10,000 contribution towards a deposit on a flat. All inter vivos transfers of value made by a person into a trust on or after 22 March 2006 will give rise to an LCT. When a person dies there is a deemed transfer of all the assets that they own at the date of their death. It is this deemed transfer that gives rise to the IHT charge on death. For more detail about PETs, LCTs and transfers on death, including the tax treatment for them, you should refer to the IHT Topic within Wills and Estates.

Question 115

PETs and LCTs

Answer 115

The relevant value for an inter vivos transfer is the amount by which the transferor's estate is reduced, rather than the face value of the asset or the amount the transferee gains. For example, if the transferor gives away one item out of a complete set, the loss to the transferor may be more than the value of the one item given away.

Question 116

Death

Answer 116

Property in the taxable estate is valued at the price it might reasonably be expected to fetch if sold on the open market immediately before the death. You will consider what assets are included in the taxable estate and special rules relating to asset valuation in the IHT Topic in Wills and Estates.

Question 117

Rates of Tax - Revision

Answer 117

The rates of IHT are set annually by the budget for the tax year which runs from 6 April one year - 5 April the following year. For tax year 2022-2023 the rates are: * £0 - £325,000 = 0% (the nil rate band (‘NRB’)) (NB. the NRB may be higher or lower in certain situations) * Above the NRB - 40% (death rate); or - 20% (lifetime rate - always 1/2 death rate - applied to LCTs) Note: There is an additional nil rate band (currently £175,000) for individuals who die on or after 6 April 2017 if they leave their family home to lineal descendants. This is known as the ‘residence nil rate band’ (‘RNRB’)) An individual’s surviving spouse or civil partner (referred to as their ‘spouse’ for ease of reference) can inherit the unused portion of their basic NRB and RNRB. This is known as the ‘transferable nil rate band’ (‘TNRB’).

Question 118

Cumulative Total - Revision

Answer 118

Cumulation is used to prevent individuals reducing their IHT liability by making a series of separate dispositions. Instead of viewing each IHT chargeable transfer (ie failed PET, LCT, death) in isolation, HMRC also consider any other IHT transfers made in the 7 years prior to the current transfer being taxed.

Question 119

Cumulative Total

Answer 119

The effect of the cumulative total is to reduce the NRB available for the current transfer. So you must calculate the value of the cumulative total before you can work out the NRB available.

Question 120

Available NRB to use for a transfer = £325,000 less the cumulative total Exemptions and reliefs - Revision

Answer 120

There are a number of different exemptions and reliefs which can be used to reduce or eliminate IHT. Exemptions and reliefs work in slightly different ways: * Gifts to certain individuals or other entities are exempt from IHT. This means that they can be made completely free from IHT and do not use up the NRB.

Question 121

Exemptions and reliefs - Revision

Answer 121

* Gifts of particular assets benefit from reliefs. This means that, where the conditions of the relief are met, the amount of IHT payable is reduced (sometimes by 100%). Some exemptions and reliefs only apply to PETs and LCTs. Others apply only to the death estate. Some apply to both.

Question 122

Exemptions and reliefs - Revision

Answer 122

The exemptions and reliefs below apply to both lifetime transfers (failed PETs and LCTs) and the death estate, and therefore should be considered for all chargeable transfers.

Question 123

Available for both lifetime transfers and death estate

Answer 123

Spouse exemption - Political party exemption Charity exemption - Exemptions for gifts for national purposes or to heritage maintenance funds Business property relief - Exemption for gifts to EBTs Agricultural property relief - Exemption for gifts to housing associations

Question 124

Business Property Relief (‘BPR’)

Answer 124

BPR is an exemption which applies to the value of qualifying business assets and is available to LIFETIME transfers and the DEATH estate. Business property includes: * a business or interest in a business eg business of a sole trader or partnership; * shares in an unquoted company; * shares in a quoted company; * land or buildings, machinery or plant owned by transferor but used for business purposes by either a company of which the transferor has control, or a partnership of which the transferor was a partner. The transferor must have owned the business assets for at least 2 years immediately prior to the transfer. Note that BPR is not available if the business consists wholly or mainly for making or holding investments.

Question 125

Rate of relief

Answer 125

* 100% relief is available in respect of transfers of a business or interest in a business or shares in an unquoted company – eg 100% relief applies to all private company shares irrespective of the size of the shareholding. * 50% applies to shares in a quoted company but only if the shareholder had control of the company (unlikely but possible) and to the land or buildings category on the previous slide.

Question 126

Rate of relief

Answer 126

Note: Where a lifetime transfer qualified for BPR when made but is re-assessed following the death of the transferor within 7 years, BPR will only be available when reassessing the transfer if the property transferred (or replacement property) still qualifies for BPR in the transferee’s hands when the transferor dies (or on the death of the transferee if earlier).

Question 127

Calculating IHT on lifetime transfers

Answer 127

In order to calculate the IHT due on a failed PET or LCT the following formula should be used: Step A – Calculate cumulative total Step B – Identify value transferred Step C – Apply exemptions and reliefs Step D – Apply NRB and calculate tax Step E - Apply taper relief Step F –Give credit for tax paid in lifetime Note that Steps E and F only apply when the IHT is being calculated after death.

Question 128

Calculating IHT on death estate

Answer 128

In order to calculate the IHT due when someone dies it is necessary to follow this 7 step process: Step 1 - Calculate cumulative total Step 2 - Identify assets included in the taxable estate Step 3 - Value the taxable estate Step 4 - Deduct debts/expenses Step 5 - Apply exemptions & reliefs (BPR fits into IHT calculation here Step 6 - Apply RNRB Step 7 - Apply basic NRB and calculate tax