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Professional 2
June 2003


Professional 2 – Public Policy and Taxation                                   June 2003
Examiner’s Model Answers

Note from Examiner

Public policy issues are, by their nature, dynamic and subjective. Answers to public
policy questions will, therefore, inevitably be shaped by candidates’ political,
economic, cultural and other perspectives as well as by their technical knowledge.
Hence, it is only on rare occasions that there is a “single correct” answer or a
“completely wrong” answer to a question on Public Policy.

The model answers therefore represent one possible answer to each of the
examination’s three Public Policy questions. In the examination, many candidates
gave answers that were different to the model answers but for which they were
awarded appropriate credit.

Public Policy Examiner’s Report – Introduction

This was the fourth examination in Public Policy and Taxation. The examination
comprised six questions, of which the first three related to the Public Policy element
of the syllabus. Candidates were required to answer any two of the three Public
Policy questions.

As mentioned in previous examiner’s reports, it is not feasible, in a single
examination, to set three questions that address issues covered by each of the nine
study sessions in the Public Policy open learning material (OLM). It therefore
remains the examiner’s aim to set questions that address each of the three syllabus
areas in every examination; but to set questions that address issues from each of the
nine OLM study sessions only over a cycle of three to four examination sittings.

Overall, the June 2003 examination paper’s questions addressed issues drawn from
each of the three syllabus areas and from four of the nine OLM study sessions, as
shown below.

Syllabus Areas                                OLM Study Sessions

Q1     1    The Policy Making Process         1    Parliamentary Democracy,
                                                   UK Constitution and Parliament
                                              4    Government Outside Whitehall

Q2     1    The Policy Making Process         4    Government Outside Whitehall
       2    Economic Policy Making            6    Economic Policy
       3    Contemporary Policy Issues

Q3     3    Contemporary Policy Issues        8    The New Public Management

The examination paper was designed so that all candidates who had prepared
themselves appropriately would be able to reach the minimum pass standard. In this
context, appropriate preparation means that candidates must have studied, and
ensured that they have understood, the key issues in each of the nine study sessions
in the OLM; and that they have read and understood all of those parts of
Contemporary British Politics (the recommended textbook by Coxall and Robins) to
which they are directed by the OLM study sessions.

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Professional 2 – Public Policy and Taxation                                     June 2003
Examiner’s Model Answers

It was, once again, pleasing to see that most candidates had read and understood
the study material fully discussed in relevant OLM study sessions. However, a much
smaller number of candidates appeared to have familiarised themselves with key
issues that were dealt with only briefly in the OLM but which were discussed in much
more detail in OLM-referenced sections of Contemporary British Politics.

The OLM emphasises, in its introduction, that public policy is by nature a discursive
and analytical, rather than a computational subject. It requires candidates to think,
reflect and to “read around”. In this context, candidates will find it helpful to develop
the habit of reading a good quality daily newspaper such as The Guardian, The
Independent or The Daily Telegraph. Many aspects of the Public Policy syllabus are
matters of “general knowledge” which are covered by the media on almost a daily
basis. The June 2003 examination questions contained opportunities for candidates
who had read beyond the OLM and prescribed textbook to gain marks significantly in
excess of the minimum pass standard. The examiner cannot, therefore, overstate
the importance of candidates keeping themselves informed about current issues in
the social, political and economic arenas by regularly reading quality newspapers or
by watching/listening to news, financial and current affairs broadcasts on the

Candidates were required to answer two out of the paper’s three questions and,
without exception, all candidates complied with this requirement. In total, 141
candidates sat the examination. The most popular question was number 2 which
was attempted by 137 candidates; following that was question 1 (111 candidates)
and question 3 (only 34 candidates).

Presentation of answers was generally of a high standard. There were examples,
however, where candidates failed to follow the basic instruction to commence the
answer to each question on a new page. Other presentational weaknesses included
extremely poor and small writing; the absence of line spaces between paragraphs;
and the physical laying out of answers in such a manner that could not be easily read
by the examiner (for example, failing to highlight key words and phrases; failing to
use bullet points when listing several factors; failing to clearly distinguish answers to
various sub-parts of questions). Although the examination has no marks that are
explicitly set aside for presentation, a weak style of presentation that makes it difficult
for the examiner to read and understand answers may lead implicitly to the loss of

Examiner’s Report – Question 1

The syllabus area addressed by this question was The Policy Making Process. The
question was designed to test candidates’ awareness and understanding of the
nature and sources of constitutions, both generally and with specific reference to the
UK constitution. It also required candidates to reflect on the extent to which UK
parliamentary sovereignty has been affected by the UK’s membership of the
European Union (EU).

Parts (a) and (b) of the question were straightforward in that they required candidates
to do little more than show awareness and understanding of OLM/textbook material.
Part (c) was more challenging in that it required candidates to analyse and evaluate,
rather than merely describe, issues relating to parliamentary sovereignty stemming
from the UK’s EU membership. This gave stronger candidates the opportunity to
demonstrate knowledge and understanding that go beyond the OLM and prescribed
textbook. However, all elements of the question were covered by the OLM, either

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Professional 2 – Public Policy and Taxation                                   June 2003
Examiner’s Model Answers

directly or in OLM references to Coxall and Robins. The most disappointing aspect
of answers to question 1 was the large number of candidates who (in part (c))
seemed unfamiliar with the basic concept of parliamentary sovereignty, even though
this is fully addressed in the OLM/textbook material. Much more encouraging was
the significant but smaller number of candidates who were able (in part (b)) to cite
non-OLM/textbook material, such as the increasing tendency of UK prime ministers
to become a source of UK constitutional change.

Although this was the second most-popular question on the paper, it was (by a small
margin) the best done. Most candidates answered the straightforward parts (a) and
(b) very well. Unsurprisingly, answers to part (c), which required analysis and
evaluation by candidates, were relatively weak, even though the issue being
examined is a topic of almost daily media attention.

Model Answers – Question 1

(a)   The three main criteria by which constitutions are distinguished from each other

      Federal or Unitary; Codified or Uncodified; and Flexible or Inflexible

      In countries with unitary constitutions, power is concentrated in one supreme
      body. In federal states, power is devolved to a number of agencies and the
      courts or similar bodies are used to resolve any conflict between these bodies.

      Countries with codified constitutions encapsulate (or codify) the main body of
      their constitutional law in a single document. In contrast, countries with
      uncodified constitutions may have many elements of their constitutional law
      recorded in writing, but this constitutional law is not codified into a single

      Codified constitutions are usually more inflexible than uncodified ones. This is
      because the procedure for amending codified constitutions normally involves
      special procedures whereas uncodified constitutions can normally be amended
      by the same process as ordinary law/or by custom and practice.

      The UK constitution is unitary, flexible and uncodified. Despite devolution to
      Scotland and Wales (and, from time to time, Northern Ireland), parliament is the
      supreme governing body and there is no federal structure in the UK. Although
      part of the UK constitution is written (eg statutory legislation), much is a matter
      of custom and convention, and there is no single codified constitutional
      document. Because the UK constitution is uncodified, it is also flexible and
      relatively easy to amend through the process of ordinary law.

(b)   The six principal sources of the UK constitution are as follows.

      Legislation. This is the main source. It comprises Acts of Parliament and
      subordinate legislation such as orders in council and rules/regulations made by
      ministers. Key constitutional matters regulated by legislation include such
      things as the conduct of elections and devolution to Scotland and Wales.

      Common Law. This is law derived from court cases and from custom. It
      includes the general principle of parliamentary sovereignty, the exercise of
      residual crown powers and decisions of courts in judicial review.

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Professional 2 – Public Policy and Taxation                                  June 2003
Examiner’s Model Answers

      Conventions are rules of constitutional behaviour which are regarded as
      binding upon those who operate the Constitution, but which are not enforced by
      the law courts. Conventions act as the “glue” in the system and make an
      uncodified/unwritten constitution workable. They include matters such as the
      dissolution of parliament by the monarch at the request of the prime minister.

      EU law. Some EU law is directly applicable to the UK. Such law includes
      judgments of the European Court of Justice and regulations from the EC and
      Council of Ministers.

      Law and Custom of Parliament. This relates to the running of parliament and
      cover the organisation of parliament’s work (eg the duty of impartiality by the
      Speaker and allocation of parliamentary time to the Opposition).

      Works of authority. There are a number of works written by authoritative
      commentators on the constitution by authors such as Bagehot (The English
      Constitution, 1967) and Dicey (The Law of the Constitution, 1885).
      Parliament’s only definitive “rule book” is widely accepted as being Erskine
      May’s treatise on Law, Privileges, Proceedings and Usage of Parliament.

(c)   Parliamentary sovereignty refers to a country’s parliament as being the ultimate
      legal authority and, in external relations, parliament’s ability to function as an
      independent entity.

      The European Communities Act (1972) gave the force of law within the UK to
      obligations arising under EU treaties. EU law now has general and binding
      authority in the UK.

      EU law takes precedence over all inconsistent UK law. It precludes the UK
      parliament from legislating on matters within EU competence, where the EU
      has formulated rules to “occupy the field”.

      Overall, the present constitutional position is that the UK’s membership of the
      EU has impaired the doctrine of parliamentary sovereignty. Parliamentary
      sovereignty, vis-à-vis the EU, can only be fully restored through the UK’s
      withdrawal from the EU by repealing the 1972 European Communities Act.

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Professional 2 – Public Policy and Taxation                                   June 2003
Examiner’s Model Answers

Examiner’s Report – Question 2

This was the most popular question on the examination paper but the average mark
awarded was, by a small margin, the second best after question 1. It addressed
each of the three syllabus areas, namely the Policy Making Process, Economic
Policy Making, and Contemporary Policy Issues.

Part (a) required candidates to explain, in the context of the European Union, the
meaning of Economic and Monetary Union (EMU). Most students identified the
European Single Currency (euro) as being a key element of the answer, but many
did not realise (or forgot to mention) that EMU also involves a single common interest
rate and monetary policy amongst participating countries.

Part (b) required candidates to present the main arguments for and against UK
participation. The key arguments are clearly outlined in the OLM and most students
were able to present these and others, especially those with an emotional rather
economic bias which are frequently a matter of debate in the media. Many students
presented the UK Chancellor’s five economic tests for UK EMU participation as their
arguments and credit was given for this where applicable.

Part (c), requiring candidates to outline the powers and responsibilities of four key EU
institutions, was generally very well answered. However, it was disappointing to see
a significant minority of students who seemed unaware of these powers and
responsibilities, even though the matter is clearly presented in the OLM/textbook
material and has been a subject of several previous Public Policy examination

Part (d), concerning the democratic deficit in EU policy making, was generally well
done by those candidates who had performed well in part (c).

Model Answer – Question 2

(a)   Monetary Union is the second stage of European Economic and Monetary
      Union (EMU). Stage one, completed on 1 January 1993, involved the creation
      of a single European market, with freedom of movement of capital, goods and
      labour between the 15 members of the EU.

      Stage two (Monetary Union) involved the creation of a single European
      currency (the euro). Twelve of the EU’s 15 members participate in Monetary
      Union. The non-participants are the UK, Denmark and Sweden. The euro was
      initially introduced in January 1999 as an option for cheque and credit
      transactions, replacing individual participants’ hard currencies in January 2002.
      A single central bank (the ECB) determines a single, common short-term
      interest rate (the ECB’s Refi rate) for all individual participant countries’.

(b)   There are many arguments both for and against UK participation in the
      European Single Currency. Most of the UK Chancellor’s Five Tests for euro
      membership may, currently, be regarded as arguments against membership,
      especially the tests that concern convergence of the UK with the Eurozone
      economies and the related potential problem of a “one size fits all” interest rate.
      Other arguments focus on emotional issues such as the loss of sterling as the
      UK’s national currency and the loss of the monarch’s head on notes and coin.
      But the most frequently cited arguments are those shown below.

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Professional 2 – Public Policy and Taxation                                    June 2003
Examiner’s Model Answers

      The main arguments for the UK’s possible future participation in the European
      Single Currency are that membership:

            reduces transaction costs, thus facilitating trade amongst Eurozone
            introduces greater price transparency, encouraging companies to minimize
             production costs in order to remain competitive;
            offers the prospect of greater economic, monetary and political stability
             within Europe.

      The main arguments against the UK’s possible future membership of the
      European Single Currency relate to:

            concerns that the UK government may have to surrender its political
            concerns that the UK will have to surrender the economic sovereignty of the
             Bank of England (over monetary policy) and possibly of the UK government
             (over fiscal policy);
            fears that greater and more harmonized regulation (business, social and
             employment) in more unified Europe will undermine the efficiency and
             effectiveness of the UK economy.

(c)   (i)     The European Council of Ministers
              Its central function is to decide EU law on the basis of proposals received
              from the European Commission.

              It is supported in its work by permanent delegations of diplomats
              (COREPER) from each member country.

              The Council’s work is divided up into 23 policy areas and decisions are
              made by unanimous, qualified majority or simple majority votes,
              depending on the issue under discussion.

      (ii)    The European Parliament
              The EU parliament is not a parliament in the traditional sense. It does not
              produce a government or any pro-active legislation but, instead, is part of
              the EU’s consultative process.

              It offers opinions on EU legislation proposed by the European
              Commission prior to consideration by the Council of Ministers and also
              after initial consideration by the Council of Ministers.

              Its main powers are to dismiss the Commission (but this has never been
              exercised and may be a formal rather than a real power); to confront the
              Commission over budget proposals; and to reject draft budgets.

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Professional 2 – Public Policy and Taxation                                    June 2003
Examiner’s Model Answers

      (iii) The European Commission

            The Commission initiates EU policy by formulating proposals that go to
            the Council of Ministers.

            It ensures that EU legislation is upheld in nation states (a watchdog role).

            It has a broad executive role in terms of supervising and implementing EU
            policies, and in managing the EU budget.

      (iv) The European Court of Justice

            The Court is the EU’s judicial authority. It deals with cases over a wide
            range of issues but most cases are concerned with business law.

            It ensures uniformity, amongst member states, in the interpretation and
            application of Community law.

            It reviews the legality of legislation adopted by the Council and the

            It rules on questions of Community law referred to it by the national courts
            of member states.

            It rules on complaints by natural and legal persons who wish to challenge
            decisions taken by the Community which affect them.

(d)   The democratic deficit is concerned with a low level of democratic
      accountability in governmental institutions.

      In the EU, the only institution that is directly accountable to the electorate
      (through direct elections) is the European parliament. But the EU parliament,
      though able to amend and reject draft law and influence the EU budget, has
      little or no democratic control over other EU policymaking institutions, such as
      the EU Commission, or EU decision makers such as the Council of Ministers.

      The key decision-making institution (the Council of Ministers) does suffer from a
      democratic deficit. Although it comprises elected Ministers from EU member
      states, the Ministers are indirectly rather than directly elected to the Council.

      Furthermore, the Council’s voting system (unanimity, qualified majority and
      simple majority, depending on the issue under consideration) means that
      Council members from individual EU member states may often be unable to
      translate the interest and wishes of their home electorate into EU policy

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Professional 2 – Public Policy and Taxation                                    June 2003
Examiner’s Model Answers

Examiner’s Report – Question 3

This was, by a long way, both the least popular question on the paper and the least
well answered with an average mark of less than 10 out of 25. The question
concerned the evolution of the ideologies of the UK’s two major political parties. The
weaker and majority of answers to this question were unable to effectively describe
how party ideology had evolved under changing leadership, especially that of the
Conservative Party, even though this matter is addressed in both the OLM and
textbook material. The weakest answers were those that were unable to differentiate
between ideology and policy/tactics.

Model Answer – Question 3

(a)   A political party’s ideological stance refers to the system of interrelated ideas
      that represents that party’s “world view” and which it is hoped will attract and
      mobilize widespread support.

      (i)    Traditional conservatism sees society in hierarchical terms as a
             command structure, held together by people exercising their allocated

             It is generally opposed to radical and or rapid change.

             It is intensely patriotic and nationalistic, seeing the preservation of the
             nation’s integrity against internal and external threats as the first task of
             political leadership.

             It has an unqualified regard for the private ownership of property and is
             unconcerned by social inequality as this is seen as the result of
             differences in energy and ability.

             Strong emphasis is placed on the rule of law and law enforcement. But it
             also believes in limited (but authoritative) government.

             Capitalism is seen as the optimal economic system because of its ability
             to generate wealth and its close link with political freedom.

      (ii)   The Conservative Party’s ideological stance under Mrs Thatcher is often
             called “The New Right”.

             Features of The New Right’s ideology include:

             Support for a free market economy. The state’s economic role is limited
             to ensuring “sound money” (ie the control of inflation), the security of
             property and the enforceability of contracts.

             Socio-economic aspects include cutting direct taxes, reducing public
             expenditure, privatising publicly owned assets, ending corporatist
             relationships with producer groups and curbing the power of trades

             There is a nationalistic desire to protect British sovereignty against
             European integration.

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Professional 2 – Public Policy and Taxation                                   June 2003
Examiner’s Model Answers

            It seeks to eliminate any social dependency culture.

            It seeks a strong state role in maintaining internal order, external defence
            and the protection of national interests.

      (iii) Under Hague and Duncan-Smith, the Conservative                   party   has
            repositioned its ideology (“New Conservatism”).

            The main features of this repositioning include:

            Neo-liberal economics.          This relates to the search for “smaller
            government” involving lower taxes, lower public spending and reduced
            responsibilities for the state.

            Social libertarianism, whereby the Conservative Party is at ease with
            racial diversity and tolerant of a range of private sexual behaviours. It
            also involves a relaxed view of single-parent families and the co-habitation
            of unmarried couples.

            The nationalist resistance to European integration which ruled out UK
            participation in the euro for the medium term.

            Constitutional conservatism whereby the Conservative party was opposed
            to the radical reforms proposed by New Labour.

(b)   The key features of New Labour’s ideology include:

      The competition state. This involves the government taking responsibility for
      the UK’s international economic performance through, for example, competition
      and training policies.

      The idea of community. Here, a balance is sought between the Thatcherite
      focus on individuals or consumers, and the “old Labour” focus on collectivism.
      New Labour aims to stress the ideas of social interdependence and
      responsibility (the “Third Way”).

      The stakeholder society whereby individuals have rights, assets and
      opportunities, but need to fulfill certain societal obligations. Governments
      should develop policies to promote “inclusion” and to combat “exclusion”.

      Constitutional radicalism. Here, New Labour is committed to constitutional
      reforms such as devolution, a bill of rights, freedom of information, and electoral
      and parliamentary reform.

(c)   Marketisation and privatisation both seek to improve the efficiency and
      effectiveness of the economy. Marketisation attempts to achieve this by
      introducing private-sector principles into the public sector. Privatisation seeks
      to achieve this by transferring the ownership of public-sector assets to the
      private sector.

      The extent to which marketisation and privatisation are consistent with New
      Labour’s ideology is discussed below.

      Consistency with the competition state

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Professional 2 – Public Policy and Taxation                                  June 2003
Examiner’s Model Answers

      New Labour has done little to reverse the Thatcherite marketisation and
      privatisation initiatives of 1979 – 1997. it could be argued that this approach is
      consistent with the competition state ideology in that it has enhanced the UK’s
      international economic performance, especially in service sector activities.

      Consistency with the idea of community
      It is questionable whether there are sufficient controls/regulations in place to
      ensure that privatised companies consider or comply with the notion of
      community in their decision-making processes.

      Consistency with the stakeholder society
      It is debatable whether the greater freedom created by private ownership is
      consistent with the notion of a stakeholder society. Regulation of privatised
      utilities does not influence the extent to which companies apply the principles of
      stakeholding, as the power of regulators does not extend this far.

      Consistency with the notion of constitutional radicalism.
      In the context of marketisation and privatisation, this element of New Labour’s
      ideology is not relevant.

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Professional 2 – Public Policy and Taxation                                   June 2003
Examiner’s Model Answers

Taxation Examiner’s Report – Introduction

The taxation section of this paper offered the usual choice of two questions from
three, each carrying 25 marks. The three questions covered the main syllabus areas
of corporation tax, income tax, National Insurance contributions, VAT and the
principles of taxation.

Examiner’s Report – Question 4

This corporation tax question was entirely computational in nature. The question
began by asking candidates to calculate a company's Schedule D Case I trading
profit and perform a capital allowances computation. This part of the question was
done well and seemed to cause no great difficulty, but the same cannot be said for
the next two parts of the question, which called for a Schedule A computation and the
calculation of a chargeable gain. It seemed that comparatively few candidates knew
how to deal with a lease premium and that some candidates were unable to match a
disposal of shares against acquisitions. These topics are covered extensively in the
OLM and recommended textbook.

The final part of the question required candidates to calculate the company's
corporation tax liability for the accounting period. This is a core topic of the syllabus
and most candidates were able to perform the calculation fairly well. However, many
candidates omitted to give relief for the Gift Aid donation, which ranks as a charge on

Model Answer – Question 4

                                                                £            £
      Profit before taxation per accounts                                 431,200
      Add: Depreciation                                                    76,560
              Loss on sale of machinery                                     2,700
              Customer entertaining                                        11,630
              Gift Aid donation                                             2,500
              Xmas gifts to customers                                       1,000
              Increase in general provision                                 3,500
              Employee loan written off                                       500
              Professional fees                                             2,500
              Repairs                                                       1,300
      Less: Income from property                             24,000
            Investment income                                72,000        96,000
      Schedule D Case I profit (before capital allowances)                437,390

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Professional 2 – Public Policy and Taxation                                     June 2003
Examiner’s Model Answers

                                     General             Jaguar           Total
                                      Pool                            allowances
                                           £                      £             £
      y/e 31/3/2002
      WDV b/f                        123,460              28,420
      Disposals                      (11,500)
      WDA @ 25%                        27,990                                 27,990
      WDA (restricted)                                     3,000               3,000
      Additions       16,000
      FYA @ 40%        6,400            9,600                                  6,400
      WDV c/f                          93,570             25,420
      Total allowances                                                        37,390

      (There is no restriction for private use of an asset by an employee.)

(c)    Rent of £8,000 x 6/12 = £4,000 is assessable under Schedule A. The premium
       of £20,000 less 5 x 2% = £18,000 is also assessable, giving a total Schedule A
       figure of £22,000.

      S104 Holding:
                                                          No. of      Cost        Indexed
                                                          shares                    cost
                                                                           £             £
      Bought August 1989                                    2,000      7,000         7,000
      Indexation to March 1998
         (160.8 – 115.8)/115.8 x £7,000                                                 2,720
      Bought March 1998                                     1,000      8,000            8,000
                                                            3,000     15,000           17,720
      Indexation to November 2001
         (174.6 –160.8)/160.8 x £17,720                                                 1,521
      Sold November 2001                                    2,000     10,000           12,827
      c/f                                                   1,000      5,000            6,414

      The gain on the disposal is £17,173 (£30,000 - £12,827).

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Professional 2 – Public Policy and Taxation                June 2003
Examiner’s Model Answers

      Schedule D Case I                         437,390
      Less: Capital allowances                  (37,390)
      Schedule A                                  22,000
      Chargeable gains                            17,173
      Less: Charges                                2,500
      PCTCT                                     436,673
      FII (£45,000 + £5000)                       50,000
      Profits                                   486,673

      £436,673 @ 30%                            131,002
      Less: Marginal relief:
        1/40 x (£1,500,000 - £486,673)            22,730
        x (£436,673/£486,673)
      Corporation tax due                       108,272

                                         Page 14 of 20
Professional 2 – Public Policy and Taxation                                 June 2003
Examiner’s Model Answers

Examiner’s Report – Question 5

Question 5 covered income tax and National Insurance contributions. The question
was mostly computational but concluded by asking candidates to provide a narrative
description of the PAYE system.

The computational parts of the question were done adequately on the whole, apart
from the part which related to the (now defunct) Children's Tax Credit (CTC). This
was the second consecutive occasion on which the CTC had been examined but
many candidates were still unable to answer this part of the question with any
credibility. By contrast, the description of the PAYE system was often extensive and
generally covered most of the system's principal features.

Model Answer – Question 5

                                                               £          £
      Salary                                                             60,000
      Employer pension contributions                                          -
      Expenses allowance                                                  5,000
      Private medical insurance                                             630
      Free use of workplace sports facilities                                 -
      Beneficial loan £10,000 @ 6.25%                                       625
      Less: Pension contributions 7% of £60,000              4,200
            Necessary travel and subsistence expenses        4,000
            Mileage allowance deficit:
              4,000 @ 45p + 1,000 @ 25p - £1,500               550
            Allowable subscription                             250        9,000
      Schedule E income                                                  57,255

(b)   Fiona and Frank have a qualifying child living with them in 2001/02. Therefore
      CTC is potentially available.

      However, Fiona is obviously a higher-rate taxpayer whilst Frank is not, so the
      CTC must be claimed by Fiona.

      £2 of the CTC is lost for every £3 of taxable income taxed at the higher rate or
      Schedule F upper rate. Since the full CTC is £5,200 this means that the tax
      credit is entirely lost when £7,800 or more of taxable income is taxed at higher
      rates. This is clearly the case for Fiona. Therefore neither she nor her husband
      will benefit from the CTC in 2001/02.

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Professional 2 – Public Policy and Taxation                                      June 2003
Examiner’s Model Answers

                                                            Fiona           Frank
                                                                  £                 £
       Schedule E                                            57,255            14,420
       Schedule F:
         £918 + £102                                             1,020
         £603 + £67                                                               670
       Building society interest:
         £3,072 x 100/80                                         3,840
         £4,144 x 100/80                                                        5,180
                                                             62,115            20,270
       Personal allowance:
         Age 0-64                                                4,535
         Age 65-74: £5,990 - (1/2 x £2,670)                                     4,655
       Taxable income                                        57,580            15,615

        Income tax due:
                                                         Fiona           Frank
         Fiona            Frank                                  £               £
                £               £
            1,880           1,880 @ 10%                      188             188
           28,370           7,885 @ 22%                    6,241           1,735
           26,310               - @ 40%                   10,524               -
                -           5,180 @ 20%                        -           1,036
                -             670 @ 10%                        -              67
            1,020               - @ 32.5%                    331               -
           57,580          15,615                         17,284           3,026

       Less: MCA £5,365 @ 10%                                  -             537
                                                          17,284           2,489
       Less: Tax deducted at source from BSI                 768           1,036
                                                          16,516           1,453
       Less: Tax credits attached to dividends               102              67
       Tax payable (before deducting PAYE)                16,414           1,386


        (i) Fiona's basic rate band is extended by £850 (£663 x 100/78) because of the
            Gift Aid donations.

        (ii) MCA may be claimed by virtue of Frank's age. This is available in full since
             the reduction required because of the size of his income has been made in
             full against his own personal allowance.

       Primary Class 1 contributions:
          8.4% x (£29,900 – £4,535)                                       2,131

                                         Page 16 of 20
Professional 2 – Public Policy and Taxation                                  June 2003
Examiner’s Model Answers

(e)    The main purpose of the PAYE system is to collect income tax (and NIC's) at
       source from employment income. The system was introduced during the
       Second World War to deal with the greatly increased number of employees who
       were then paying income tax.

       The system provides a smooth flow of revenue for the Government throughout
       the tax year and avoids the need for employees to put money aside each week
       or month to pay a year-end tax bill. The system is also cheap to run, since
       employers act (in effect) as unpaid tax collectors on behalf of the Inland

      The main features of the PAYE system are as follows:

       •    Employers deduct income tax and NIC's from employees when paying
            their wages and salaries. The sums deducted in a tax month (together
            with the employer's secondary NIC's) must be paid over to the Inland
            Revenue within 14 days of the end of that month.
       •    The PAYE system applies to all payments assessable under Schedule E,
            including "payments" taking the form of assets which are readily
            convertible into cash.
       •    Each employee is issued with a tax code by the Inland Revenue. This
            code reflects the employee's entitlement to allowances and reliefs. The
            tax code may be adjusted to collect tax due on benefits-in-kind or to
            account for tax under-paid or over-paid in previous years.
       •    The system is cumulative in nature. With the aid of tax tables provided by
            the Inland Revenue, the employer uses the tax code to determine the
            amount of tax-free pay to which an employee is entitled for the tax year to
            date. This amount is then subtracted from the employee's gross pay to
            date, giving the taxable pay to date. A further table look-up then
            determines the amount of tax due for the year to date. The tax already
            paid for the year (if any) is then subtracted, giving the tax due for the
            current week or month.
       •    The aim is that, at any time of year, the tax paid so far during the year
            should accord with the amount due so far for that year. At the end of the
            year, the system should have automatically collected the correct amount
            of tax and it should not be necessary to issue the employee with a further
            tax demand or make a tax repayment.
       •    At the end of each tax year, employers are required to submit an end-of-
            year return to the Inland Revenue, summarising all employees' gross pay
            and tax paid for the year. A certificate of gross pay and tax deducted
            must also be provided to each employee at the end of the tax year on
            form P60.
       •    The system as originally designed revolves around the use of printed tax
            tables and forms. However, many employers now run computer-based
            payroll systems in which disk files have replaced the printed tables.
            Similarly, there is an increasing trend for end-of-year PAYE returns to be
            submitted to the Inland Revenue by electronic means.

                                         Page 17 of 20
Professional 2 – Public Policy and Taxation                                  June 2003
Examiner’s Model Answers

Examiner’s Report – Question 6

The last question on the paper was a narrative question composed of five parts. The
first part was concerned with the badges of trade, the next three parts covered VAT
and the final part tested candidates' understanding of tax evasion and tax avoidance.

As regards the first part of the question, there was some confusion between the
badges of trade and the tests which are used to distinguish between employment
and self-employment. Apart from this, most candidates gave a comprehensive list of
the badges of trade but some candidates failed to provide the requested explanation
of each badge.

The VAT parts of the question were answered extremely well by most candidates.
However, some candidates confused the cash accounting scheme with the annual
accounting scheme and there was some further confusion between zero-rated
supplies and exempt supplies.

Finally, most candidates knew the difference between tax evasion and tax avoidance
and could state that tax evasion is a criminal offence which is punishable by law.
However, very few candidates could explain the courts' view of tax avoidance

Model Answers – Question 6

(a)   (i) The badges of trade are:

          •   Subject matter of the transaction:

              -   If the assets concerned are of a type which might normally be
                  acquired for the company's use or as an investment, this suggests
                  that trading is not taking place. Otherwise, the profit arising on the
                  disposal is more likely to be treated as a trading profit.

          •   Length of the period of ownership:

              -   Trading stocks are normally retained for only a short period before
                  being sold. Assets acquired for use or as an investment are
                  generally retained for much longer. So if assets are bought and sold
                  within a short space of time, this suggests trading.

          •   Frequency of transactions:

              -   The more often that a company repeats a certain type of transaction,
                  the more likely it is that the activity will be construed as trading.

          •   Supplementary work:

              -   A company which buys an asset, performs work on the asset so as
                  to make it more saleable and then sells the asset is more likely to be
                  regarded as trading than a company which simply buys and sells an
                  asset without performing any supplementary work.

          •   Reason for the sale:

                                         Page 18 of 20
Professional 2 – Public Policy and Taxation                                   June 2003
Examiner’s Model Answers

              -   The circumstances which have prompted the sale of an asset might
                  be taken into account when deciding whether trading has occurred.
                  A sale necessitated by a sudden urgent need for cash is less likely
                  to be regarded as a trading activity than a sale made in the normal
                  course of events.

          •   Motive for acquiring the asset:

              -   The presence of a profit motive when acquiring the asset provides
                  strong evidence of trading.

      (ii) Although trading profits and chargeable gains are both assessed to
           corporation tax, it is important to distinguish between them for the following
           main reasons:

          •   The rules of computation are different. In particular, the rules on
              allowable deductions differ and chargeable gains attract indexation
          •   Trading profits can be used to relieve trading losses brought forward,
              whilst capital gains can be used to relieve capital losses brought

(b)   A registered person may join the cash accounting scheme so long as:
      • the person's taxable turnover (excluding sales of capital items) is not
          expected to exceed £600,000 in the next 12 months, and
      • the person's VAT returns are up to date, and
      • all amounts of VAT due to be paid to Customs and Excise (including any
          penalties and interest) have in fact been paid, or the person has come to an
          arrangement for such payments to be made by instalments, and
      • within the previous 12 months, the person has not been convicted of a VAT
          offence or assessed to a penalty for VAT evasion involving dishonest

      The main consequences of joining the scheme are:
      • output tax is accounted for in the tax period in which payment is received
         from the customer
      • automatic bad debt relief
      • input tax is reclaimed in the tax period in which payment is made to the

(c)   (i) Exempt supplies include insurances and most education and health
          services. Zero-rated supplies include food, water and books.

      (ii) A person who makes only exempt supplies is not making taxable supplies
           and cannot register for VAT. The person must not charge VAT to
           customers and cannot reclaim input tax.

          A person who makes only zero-rated supplies is making taxable supplies
          and must register for VAT if turnover exceeds the prescribed threshold.
          The person may register voluntarily if turnover does not exceed the
          threshold.  Having registered, the person charges VAT (at 0%) to
          customers and may reclaim input tax.

                                         Page 19 of 20
Professional 2 – Public Policy and Taxation                                     June 2003
Examiner’s Model Answers

(d)   (i) A person whose annual taxable turnover exceeds the registration threshold
          must register for VAT. Registration is also required if there are grounds for
          believing that turnover in the next 30 days alone will exceed the threshold.
          A person who is liable to register but who fails to do so is still a taxable
          person and is personally responsible for the output tax due in relation to
          supplies made since the date on which registration should have occurred.

          When deciding whether or not the registration threshold has been
          exceeded, it is necessary to aggregate the taxable turnover from all of a
          person's business activities. The registration relates to the person, not to
          an individual business.

      (ii) A person may register voluntarily so as to be able to reclaim input tax. It will
           be necessary to charge output tax to customers but this will not entail a loss
           of custom if the person makes only zero-rated supplies or makes supplies
           only to other registered persons (who can reclaim any VAT which is
           charged to them).

          Another reason for registering voluntarily might be to give the impression of
          an established business.

(f)   Tax evasion (which is illegal) involves dishonest conduct and includes actions
      such as concealing a source of income or claiming allowances and reliefs to
      which the taxpayer is not entitled. The courts take a serious view of tax
      evasion and can inflict substantial fines and/or terms of imprisonment on the

      Tax avoidance (which is legal) involves the sensible arrangement of a
      taxpayer’s financial affairs so as to minimise his or her tax liability. Since tax
      avoidance is not illegal it cannot be punished by the courts. However, in recent
      years the courts have taken the view that totally artificial tax avoidance
      schemes consisting of a preconceived series of transactions which have no
      aim other than tax avoidance should be ineffective for tax purposes.

Examiner’s Report – Summary

The taxation section of this paper concentrated on the core areas of the tax syllabus
and should have been fairly straightforward for the well-prepared candidate. It is
pleasing to report that most candidates coped fairly well with the taxation questions.
The minority who did not revealed a lack of knowledge which could easily have been
rectified by means of adequate preparation.

                                         Page 20 of 20

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