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Tax answers Sept03


  • pg 1
									                 Taxation exam September 2003

                           Notes to questions
1 Jordan
Lifetime transfers
10/2/94 – discretionary trust so chargeable transfer (s 3) of £194,000 after two
annual exemptions (s 19). Within NRB (s 7 and Sched 1) – no lifetime tax.
All the other gifts were PETs when made (s 3A), so no tax during lifetime.

Review of gifts within seven years of death
The gifts in 1994 are both outside the seven year period (starts Oct 1995) so no
extra tax is due. (The cottage was a PET and is now exempt but it is also a GWR
(FA 1996 s102) so features in the calculation on estate on death.)

20/3/99 AM Trust – Gift was a PET after annual exemptions of £256,000. It is
within seven years of death so is now chargeable (s 3A(4)). The 1994 gift into the
disc trust has used up £194,000 of the NRB leaving £56,000.
£56,000 chargeable at 0%           £0
£200,000 @ 40%                     £50,000
Taper relief (s 7(4)) (3-4 years between gift and death) 80% of £50,000 = £40,000
tax to pay.
This is payable by the trustees.

The annual Christmas presents are exempt under the small gifts exemption (s 20).

Estate on death
The residue of the estate is exempt as it is left to his wife (s 18). The expenses of
winding up the estate are not deductible from the estate (they would reduce the
exempt transfer to the spouse anyway).
This means the chargeable estate on death is made up of the guns, the Boots
shares and the cash legacy of £200,000, plus the tax on those gifts (the will does
not mention tax so the legacies are presumed to be free of tax – s 211.
Bequests to children total £600,000

£600,000 grossed up at 5/3 =                                    £1,000,000
To this must be added any gift over which he has reserved
a benefit. The continued visits to the cottage would be likely
to be regarded as constituting sufficient benefit –
Rev Statement Nov 1993
GWR*                                                            £ 100,000
Total chargeable estate                                  £1,100,000
Charged at 40% = £440,000.
(Although the discretionary trust has “dropped out” the A&M trust uses up all the
NRB on death.)

*I have assumed that the GWR is not grossed up although the position is not free
from doubt, and either grossing up or not was ok.
The children receive their bequests in full and the residue bears the tax (which is
thus borne by the surviving spouse).

3 i)         The classical system taxes the profits of a company under corporation
tax and then, if the profit is distributed to an individual shareholder, it is taxed
again in the hands of the shareholder. Retained profits are taxed once, distributed
profits are taxed twice

The present system of taxing companies and shareholders in the UK limits the
disadvantage of double taxation of distributions. As under the classical system, the
company pays tax on all corporate profits. However, distributions carry with them
a 10% non-repayable tax credit. What happens then depends on whether the
shareholder is a taxpayer with income including dividends over the top of the
basic rate band.

Income below the basic rate band.
Dividends in the UK are grossed up and taxed at 10%. Given the 10% tax credit,
there is no extra tax paid on distributions. Effectively, the only layer of tax which
is borne on the dividends is corporate tax.

Income over the top of the basic rate band
Dividends, grossed up at 10/9, are treated as the highest slice of income, and to the
extent that they exceed the basic rate band, they are taxed at 32.5% rather than the
40% which would normally apply. This means, together with the tax credit, that
although there is some double taxation of distributed profits, it is less than it
would be under the classical system.

Both systems treat dividends as an application of profits, not an expense in the
making of profits (ie dividends are not tax-deductible).

(ii)        The main difference between a cumulative gifts tax is that the level of
gift taxation is more in line with the wealth of the individual than a system such as
that operated by the UK which broadly taxes gifts on death and within seven years
of death.
The advantages of the UK system
- encourages lifetime giving (maybe a good thing or not)
- simpler, as most lifetime gifts can be ignored
The disadvantages of the UK system
- Less fair as the level of taxes depends on when the estate was gift away rather
than how much
- Easier to avoid by using lifetime gifts
- Does little to tackle the unequal distribution of wealth in the UK
- Probably disproportionately hits middle wealthy individuals rather than the
really wealthy who can afford to give away early.

(iii)        In relation to a tax like CGT which looks at the difference between the
acquisition cost of an asset and the proceeds of sale, it seems unfair not to give
relief for the effects of inflation in the meantime, as the gain on the asset may just
reflect the change in the value of money, and not represent any real gain. For
example, an asset which cost £10,000 ten years ago might cost £20,000 today. It
is the same cost in real terms, the difference just reflecting the change in the value
of money. So if that asset is sold for £20,000, there is no real gain and therefore
there should be no tax.
The UK system has struggled to cope with inflation. Originally there was no
indexation relief. Then, relief was introduced for gains after 1982. (Gains before
1982 were wiped out for tax purposes by the re-valuation of assets at March 1982
values.) Indexation relief involved applying the shift in the retail price index to
the acquisition cost and other allowable expenditure on the asset. Rather unfairly,
it could not create a loss or turn a gain into a loss.
Indexation was proving complicated to operate and in light of the drop in the rate
of inflation, it was replaced in relation to gains made by individuals (companies
still receive indexation relief). With effect from 1998, there is no further
indexation but taper relief, which increases with the length of ownership of the
asset, and depends on whether the asset is a business asset or not. Taper is very
much more generous for the taxpayer than indexation where the asset is a business
asset. In relation to other kinds of asset, the advantages are much less clear.
Taper relief is supposed to be easier to operate than indexation, but as there have
been many changes to the relief in its first few years of operation, and for many
years, indexation allowance will have to be calculated as well (where the asset
was owned before April 1998), the simplification is not yet fully felt.

3   CGT

i) All references to TCGA 1992 Sched A1
(i)    A factory owned by Jack. Not being shares, the position is determined by
       para 5. This is only a business asset if the company is qualifying in relation
       to Jack (para 5(2)(b)). Para 6 defines a qualifying company. The company
       is a trading company and is unlisted (para 6 (1)(a) and (b)(i)). So the
       factory is a business asset.
(ii)   Jill’s shareholding in Pailofwater Ltd.
       This is also a business asset. Para 4 determines the classification of shares.
       Is the company qualifying in relation to Jill? Yes – it is an unlisted trading
       company - a qualifying co for Jill (para 6(1)(a) and (b) – she satisfies all
       the tests in (b) although only one is necessary).
(iii)  Shares in Silverbells Investments Ltd, an unquoted investment company,
       held by Mary. Shares again so is the company qualifying in relation to
       Mary? Yes it is a business asset as although it is not a trading company (so
       it fails para 6(1)) it passes the tests in para 6(1A). She is an employee with
       no material interest (para 6A defines material interest as broadly owning
       or controlling more than 10% of the shares)
(iv)   Shares in Silverbells owned by Polly. Not a business asset as Polly has a
       material interest (para 6(1A) and 6A)
(v)    Patent - Business asset (para 5(2)(a))
(vi)   Satellite launcher . No taper for companies so irrelevant whether it is a
       business asset or not.
ii)         Juniper
Ford Mustang Convertible- exempt – either a wasting asset (s 45) or a passenger
vehicle (s 263 - there is no reason why this is not suitable for use as a private

Royal Doulton china collection
Actual gain :
Proceeds                       £ 6,900 (s 18)
Less acquisition cost          £ 2,500
Unindexed gain                 £ 4,400

£2,500 180 – 120                  £ 1,250
Indexed gain                      £ 3,150

Chattel exemption s 262 – gain restricted to £5/3 £900, or £1,500.
Take this as the gain as it is lower than the indexed gain.

Taper relief – non-business asset, QHP April 1998 – April 2002 = 4 years plus
bonus year = 5
           85% of £1,500 = £1,275

House - Exempt - TCGA 1992 s 222

Because of the s 165 claim, her deemed acquisition cost of £10,000 under s 17 is
reduced by the gain which the sister would have been deemed to have made in the
absence of a claim.

The sister’s gain would have been
Proceeds of sale                 £10,000
Less acquisition cost            £ 5,000
Gain                             £ 5,000

There is no indexation on this as there the shares were acquired just as indexation
was removed (April 1988) and there is no taper because the s 165 claim means
that there is no gain to taper.

Juniper’s acquisition cost is thus £10,000 (market value when she acquired the
shares) less £5,000 (her sister’s held over gain) = £5,000.

       Proceeds of sale           £12,000
       Less acquisition cost      £ 5,000
       Gain                       £ 7,000
Taper – owned from October 2001 – November 2002 QHP which gives a QHP of
one year , business asset (Sched A1 para 4 and 6(1) - unquoted trading company)
so 50% of gains chargeable, or £3,500.
Total gains:
£1,275(china) and £3,500 (shares) =       £ 4,775
Less annual exemption                     £ 7,700
Chargeable gains                          £ nil

4.          Harold
Harold’s profits will be taxed under Schedule D case 1. In order to be deductible,
expenditure in the context of a trade must be revenue rather than capital and
satisfy the wholly and exclusively test (s 74).

The costs of travel from home to work: not deductible as it is not wholly and
exclusively incurred for the purposes of the trade. At least part of the reason for
the expenditure is personal. The salt allergy is a red herring.

The costs of travel around the country: very likely to be deductible as “wholly and
exclusively” incurred. Only thing which would sink him is if he used the fairs to
purchase for his own collection.

The purchase of books for his personal collection. Not deductible as personal
expenditure so not for the purposes of the trade.

Waistcoats: likely to be deductible. Although in general clothes (as distinct from
uniforms) are not deductible, I think Mallalieu can be distinguished. There she
had subconscious motives of warmth and decency. Waistcoats are different and
one would be hard pushed to find subconscious personal motives here. So, seems
to satisfy wholly and exclusively requirement. Would have a job persuading the
Inland Revenue though.

A subscription to the magazine “Bookbuyers Monthly”.
In contrast to Fitzpatrick (Schedule E case), he doesn’t have to satisfy “in the
performance”, so probably deductible. Again, only problem is if the hobby gets in
the way.

Entertaining – not deductible s 577

Wages and taxi fares – both deductible as expenditures on employees are
deductible as they are for the purposes of the trade, except where there is some
obvious other reason for the expenditure (eg father employs son as one of his
employees. Pays for son to go on holiday but not other employees. Expenditure is
personal rather than for purposes of trade. )

The membership of the Scotch Whisky Association: duality of purposes, not
wholly and exclusively, not deductible.

The dehumidifier – capital expenditure so not deductible.

Accountant’s bill –£1,000 for drawing up the accounts is for the purposes of the
trade as it is very useful for traders to know how profitable they are. Fighting a
tax bill however is not for the purposes of the trade, but for the purposes of paying
less tax. : Smiths Potato Estates.

On the whole this question was answered competently and the correct tests
applied. A couple of candidates answered on the basis that the expenditure had to
be necessary and in the performance of the duties which was a very serious error.
Two common mistakes. One related to the waistcoat – many answers just blindly
applied the normal rule of Mallalieu without thinking through the possibly
relevant distinctions.
The other related to the taxi fare paid for the employee. A good proportion of
answers started applying the rules about deductibility of travelling expenses under
Sched E and concluded that because the travel was home to work it was not
deductible. This collapses two separate issues:
First, is it deductible in the computation of Harold’s profits? Yes, because
expenditure (within reason, and revenue rather than capital) on employees is
deductible, whether it is in the form of wages or other benefits.
Second, is the cost of the taxi taxable on her as a benefit in kind? Depends on
whether she is a higher or lower paid employee, and might depend on the
contractual circumstances. If she is a higher paid employee, it is a taxable benefit,
cost to employer, and she gets no matching deduction because it fails s 198. If she
is a lower paid employee, it depends on how the arrangement is organised. If he
just reimburses her, it is taxable with no matching deduction. If however it is
clear that the benefit is the taxi ride home (eg the cab driver knows he can only
take her to her home and will bill Harold for the fare) then because taxi rides
home are not convertible this will not be taxed.

5.          Mitch
(I have put in the answers to the written exercise 2003-04 for this one in order to
take into account ITEPA 2003)

Employment with band: taxed as employment income (you are told he is
employed, so not worth discussing whether there is a contract of service or
services) and because his earnings are £9,000 per year he is in higher paid
employment for the purposes of taxing benefits.

Reimbursement of travelling and overnight expenses:
Under ITEPA, the general rule is that reimbursement of expenses is taxable (s
70(1)) but this does “not prevent the making of a deduction under”, inter alia, ss
337 and 338 (s 72). So the reimbursement for the travel is taxable, but Mitch will
be able to claim a matching deduction if he can satisfy either s 337 or s 338 . It is
not entirely clear whether he is performing his duties whilst travelling (s 337) but
the expenses will certainly qualify under s 338 as they are “attributable” to his
“necessary attendance at any place in the performance of the duties” and the travel
is not “ordinary commuting”.
The Inland Revenue regard associated overnight expenses as part of travelling
expenses. This is from the Employment Income Manual:
EIM31815 - Travel expenses: general: accommodation and subsistence: include associated
Sections 337 to 339 ITEPA 2003
Travel expenses include the actual costs of travel and also the subsistence expenditure and other
associated costs that are incurred as part of the cost of making the journey.

The cost of business travel includes the cost of any necessary subsistence costs attributable to that
journey. If an overnight stay is needed then the cost of the accommodation and any necessary
meals is part of the cost of business travel. Even where an employee stays away for some time and
the travel expenses are deductible, the cost of meals and accommodation is part of the overall cost
of the business travel.”

Damage to the hotels: who is legally responsible for the damage – the employer
(through the doctrine of vicarious liability) or the employee? I am no expert on
vicarious liability but I gather it only applies to acts within the general scope of
the employee’s employment and so I would very much doubt the employer is
responsible. If it is Mitch himself who is liable in damages, this becomes a case
where the company is meeting a liability of the employee and so is taxable –
Nicoll v Austin. If, on the other hand, the employer is liable, I cannot see the
benefit to Mitch.

The meeting of the legal expenses will definitely be taxed (either as provision of
the benefit of legal services under ITEPA ch 10 if the employer engages the
lawyer or as “earnings” if the employer just pays the employee’s bill under the
Nicoll v Austin principle above). Mitch will receive no matching deduction
because incurring expenses in relation to criminal behaviour fails just about every
part of s 336. He could not possibly succeed on the same basis as the stockbroker
in McKnight v Sheppard succeeded.

Criminal fines – not deductible by Mitch for the same reasons – see again
McKnight v Sheppard.

Clothes expense: not deductible: Mallalieu.

Tickets – tricky – because of the difference between the marginal cost and the
convertibility value.

Higher paid employees are normally charged on the marginal cost to the
employer. This is probably fairly low (Pepper v Hart). If the tickets are
convertible, the convertibility test means that the face value is the value taken.
(Whether they are convertible depends on whether it is legal for them to be sold
on, and this is likely to be ok provided they are not sold for more than their face

The answer involves the new ss 62 & 64 in ITEPA. Section 62 says that earnings
includes benefits (bringing in by implication the old convertibility test).
Paraphrasing, s 64 says that where you get different amounts under “earnings” and
under the “benefits code”, it is the higher amount which is the taxable figure. So,
if the tickets ARE convertible, it is the face value which is taken. (Even if the
tickets are very popular and can be sold at a premium, this is likely to be
prohibited by the terms of the ticket, and so the convertible value remains the face
value rather than the de facto market value.)
It does not matter whether he actually does sell the tickets or not – it is not what
he converts the tickets into which matter, just whether or not they are convertible.

Pension – employer contributions to approved schemes are not taxable as an
emolument – ITEPA ss 307, 308.

The position of the employer must also be considered – are the various payments
he incurs to Mitch or on his behalf likely to be deductible under the “wholly and
exclusively principle”?

The starting position is that payments made to or for the benefit of an employee
are deductible. Take pension contributions as an example. No one would doubt
that contributions by an employer are deductible under the wholly and exclusively
requirement as they are simply surrogate wages. The fact that the benefit of the
payments arises to the employee after the employment has ceased does not change
that fact. Payments made by employers to employees should be deductible unless
they are capital, or made for some reason other than the employer or employee
relationship, or are excessive. So I would take the view that as long as the
payments are getting Mitch out of an expense, they are deductible, although there
is no direct authority for this and there is room for counter argument.

Articles – payments are taxed under Schedule D – probably case Case VI rather
than II as he does not have a profession as an author.

Waiter’s wages – is he a lower paid employee? Taking into account taxable tips
(Calvert v Wainwright) the amount he receives is under the limit of £8,500, but it
is not how much he gets paid which determines whether he is a HPE but the
“earnings rate”: ITEPA s 217. A quick glance at s 218 tells you that you need to
work out what the employee would have received had he been working the full
year. He is employed as a roadie for three months so even if he had been working
for the full nine months as a waiter, you would multiply £7,000 x 12/9 which
gives £9,333. You can be reasonably confident that he is a HPE in relation to this
employment as you know that he has not been working for the full nine months as
he has also claimed JSA. As he has worked less than nine months, the figure for
the earnings rate will be even higher.

Uniform: either not taxable as not a “benefit” ( does one benefit from a uniform?)
or taxable with a matching deduction : ITEPA ss 70/72 (Mallalieu v Drummond)

Free meal: taxable at marginal cost, unless at a staff canteen/business premises
ITEPA s 317 (v. doubtful).

Job-seekers’ allowance: taxable s 660 table A (at least in part – some bits of the
JSA are not taxable s 670 et seq but I didn’t expect reference to these.)

Rent – exempt under Rent a Room relief F(No 2) A 1992 s 59 and Sched 10.

Not so well answered as qu 4 – most answers were not sufficiently precise. For
example, the points about the taxation of the reimbursement and matching
deductions was often rolled into one. Similarly, very few worked their way
through the issues surrounding the damage, expenses and fines. Not many got the
point about the tickets (although this was difficult and not regarded as a serious
mistake). No-one thought about the possibility of him being a hpe in his role as a

6. George
Taxed under Schedule D case 1 on profits of accounting period ending in tax year
2002-03, i.e. profits of period to 30 Sept 02, or £18,000. To this will be added the
set-aside grant of £8,000 which will be treated as trading income (grants which fill
in holes in profits are treated in the same way as the profits they replaced - London
and Thames Haven Oil v Attwooll).

Hay – the £315 is likely to be treated as part of the profits from farming rather
than as a separate trade of hay cutting.
                            £ 8,000
                            £ 315
Total trading income        £26,315

The rental income is taxed under Sched A on a fiscal year basis, so 9 x £500
(April 2002 – Dec 2002) and 3 x £600 (Jan to March 2003).
Total Sched A income = £6,300.

Shed – capital expenditure, not deductible (availability of a capital allowance is a
separate issue which you were not expected to cover).

Receipt for servitude – this is a one off payment. It reduces the value of a capital
asset and is clearly itself capital: McClure v Petre. A regular payment for annual
use would be revenue.

Dividends and interest both received net and grossed up to £2,000 and £1,000

Bequest – not income (no Schedule, not capable of being recurrent for D case III)
           Non-savings income
           Schedule D                   £26,315
           Schedule A                   £ 6,300
           Less personal allowance      £ 4,615

           0 - £1,920 @ 10%                                       £ 192
           £1,920 - £28,000 @ 22%                                 £ 5,737.60
Tax cf                                                         £5,929
Savings income
          Sched D Case III £800 x 5/4 =         £ 1,000

          Taxed at 20% (sufficient basic rate band left)       £ 200

          Dividend income £1,800 x 10/9 =       £ 2,000

          He has used up £28,000 + £1,000 of lower and basic
          rate band (ceiling £29,900). This leaves £900
          of BRB remaining for the dividend income

          £900 at 10%                                          £ 100
          £1,100 @ 32.5%                                       £ 357.50
          Tax                                                  £ 6587.10
          Less tax credits
          Interest              £200
          Dividends             £200                           £ 400.00
          Tax to pay                                           £ 6,187.10

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