Technical Tax Debrief Maia (June 19)

In this article, I will be taking you through a technical debrief of Maia which was Question 1 of the March/June 2019 Advanced Tax Exam. I recommend all of you purchase the Kaplan Exam Kit which is an invaluable resource for your preparation. The question is on Page 65 of the kit. Alternatively, you can download the question from the ACCA website under past exams. However, this has not been updated for FA19 which is examinable from June 2020 to March 2021. This question is also relevant for the ICAEW BPT exam or the CTA Individuals Advisory Module.

In this scenario, Maia is a wealthy client who wants to provide financial assistance to her nephew, Josh. This is a common occurrence in the UK due to the high cost of rents where many young people leaving University have to rely on their family until they are in a more stable position, so it is a very practical real-life scenario.

 Here, the examiner has specifically stated that no explanations are required so marks are only awarded for the computations. However, I will be explaining what is required so you understand the methodology.

Josh needs ￡2,500 for 2 years so the cash required is 2500 x 24 = 60,000.

His income is subject to both income tax and employee NIC, so we need to find his post-tax income.

Josh will have taxable benefits in relation to the shares (2,100-300=1,800) and the gift of the home cinema system (20% x cost of 1,700 =340). However, the mobile phone is a tax-free benefit even if available for private use.

The dividend income of ￡420 is exempt as it falls within the ￡2,000 nil rate band.

Josh’s income tax for 20/21 is 25,200 + 1,800+340 = 27,240-12,500= 14,840 x20% = ￡2,968

In terms of employee NIC, this is only payable on the salary. The shares are not cash convertible benefits so there is no employee NIC on the share allocation.

Employee NIC is 25,200-8,632 x 12% = 1,988

This means that Josh has after tax income for 20/21 of 25,200+ 420= 25,620 less (2,968 + 1,988) = 20,664

With regard to 21/22 , Josh’s situation is identical with the exception of having to pay the tax on the share allocation of 1,800 so will save tax of 1,800x20% or 360 . This means that his after tax income will increase from 20,664 to 21,024.

To meet his expenses of 60,000 Josh needs Maia to give him 60,000-20,664-21,024 = 18,312 of income

In terms of the 3 options Maia is considering, the examiner now wanted you to quantify Josh’s post-tax income for the first two options so it is necessary to compute any income tax he will pay on the income.

With regard to lifetime gifts, there are both CGT and IHT implications for Maia and it is important not to confuse the two taxes.

Option 1 : Gift Of Investment property

As Josh would now own the property, he will be receiving rental income each month of ￡1,100 from July 2020 to March 2021 or 21 months.

He must pay income tax at 20% on the income so his after-tax income is 80%. (1100 x21x80%= 18,480)

The manager is unsure if the property is FHL (furnished holiday lettings) or not. FHL is a business asset while the normal rental property is an investment asset.

CGT For Maia

For gifts, the market value is used as sale proceeds. Maia would have a gain of 370,000-130,000= 240,000

If the property is FHL, then business assets are eligible for entrepreneur’s relief and taxed at just 10%. Maia’s CGT liability would be 24,000.

Business assets are eligible for gift relief and Maia and Josh could make a joint election within 4 years to postpone the gain until Josh sells the asset in the future. As a result, there would be no CGT payable by Maia. The gain of 240,000 would simply be deducted from the cost of 370,000 to give a base cost of 130,000 going forward.

IHT Implications for Maia and Josh

The gift is PET valued at ￡370,000 and is exempt as long as Maia does not die within the next 7 years. If Maia dies within 7 years, her nil rate band of ￡325,000 is available as she already uses her annual exemption of ￡3,000 each year.

However, in computing the remaining NRB we must consider any chargeable transfers in the previous 7 years which would have soaked up part of her NRB.

Tax on death is computed at a rate of 40% but will be reduced by taper relief if the gap between the gift and the date of death is at least 3 years.

If the property is FHL, then business assets are eligible for 100% business property relief as Maia has owned the asset for at least 2 years.

However, Maia and Josh would have to prove to HMRC that the property is operated as a business with substantial involvement by her and Josh (similar to a sole trader business).

BPR is only available on Maia’s death if Josh still owns the property and it is still relevant business property at her death. This means that if Josh chose to run the property through a managing agent as an investment then no BPR would be available.

Option 2: Gift Of Shares In An Unquoted Trading Company

CGT For Maia

Maia has previously postponed her father’s gain of 140,000 under gift relief so her base cost is 375,000 -140,000=235,000

When Maia gifts the shares to Josh, the deemed sale proceeds will be market value of 420,000 so the gain is 420,000-235,000= 185,000

Unquoted shares are a business asset for gift relief but because the company has 16% investments, it is only possible to postpone 84% of the gain (185,000 x84% =155,400)

16% of the gain or 29,600 will crystallise immediately and would result in a CGT liability of 29,600 x20% =5,920.

IHT Implications for Maia and Josh

The gift is a PET valued at 420,000 and would only be taxable if Maia dies within 7 years similar to the gift of the investment property.

Usually, unquoted shares are eligible for 100% BPR but as Maia has owned the shares for less than 2 years, no BPR is available. If BPR was available, it would be restricted to the value of the business assets. Remember, this is not the same as chargeable business assets as there are no exempt assets for IHT.

Option 3: Gift Of Monthly Cash of ￡1,100 from July 2020 

Josh will not have to pay income tax on the receipt of cash from Maia so his after tax income will be 1,100 x 21 months =23,100

CGT For Maia

Cash is an exempt asset for CGT so there are no CGT implications for Maia .

IHT Implications for Maia and Josh

The gifts out of income earned by Maia of ￡1,100 x 12 = 13,300 per year would be exempt from IHT as they come out of the income earned by Maia and do not reduce her capital or wealth.

In order for the income exemption to apply, Maia must demonstrate that the gifts do not reduce her standard of living and it is part of a series of the gifts. The examiner has confirmed that Maia has significant personal wealth, so these conditions are satisfied.

Conclusion

While the examiner did not ask for a recommendation, clearly the last option is the most beneficial as there are no income tax, CGT or potential IHT liabilities arising.

The most tax-efficient method of supporting Josh would be for Maia to give him cash of ￡1,100 each month.