Description
BUSINESS TAXATION
REVISION QUESTIONS AND ANSWERS
Question 1 : The Middleton Family
You have just received a letter from Mr and Mrs Middleton who have been planning for their future and for the future of their daughter Kate who is about to leave home and get married. They currently own the following assets:
- Their main residence in Surrey purchased by Mr Middleton for £200,000 in June 1989.
- A holiday home in Wales purchased jointly for £150,000 in January 1995.
- A flat in Surrey purchased as an investment property by Mrs Middleton for £120,000 in May 2002.
They wish to ensure that Kate has a source of income in the future as they are keen to become grandparents and do not want Kate to feel that she has to continue working but would like to encourage her to start a family. The Middleton family have informed you that the flat could be rented at a rate of £15,000 per year and the holiday home is usually rented commercially for 25 weeks a year on average at a rate of £600 per week.
Mrs Middleton works part time earning £18,000 per year. Mr Middleton is a company director and earns £60,000 per annum.
The Middleton’s are undecided as to which of the following courses of action would be the most beneficial:
OPTION ONE:
Sell their main residence to a third party and move into the flat. They would then gift the holiday home to Kate.
OPTION TWO:
Stay in the family home and sell the holiday home. They would gift the flat to Kate.
The current market values of the three properties are as follows:
- Main residence £600,000
- Holiday home £350,000
- Flat £220,000
Requirement:
You are required to draft a letter to Mr and Mrs Middleton explaining the income tax and capital gains tax consequences of each of the above two options and any suggestions you would make to minimise their tax liability in each case.
There will be marks awarded for presentation (2 marks) Max word limit 1,000 words (Total 30 marks)
Question 2: Katie Rice
Katie Rice is a well-known fashion model and businessperson. She earns over £400,000 per year and has many investments including several businesses. Katie has recently married her second husband, Rock Idle, an out of work musician who has no income or assets in his name.
Katie’s ex-husband, Paul, has just won a large financial settlement against her and the courts have ordered Katie to pay Paul £600,000 in cash. Katie currently only has £250,000 of cash available and will therefore need to sell some assets to raise the balance. She has asked for your advice as to which assets should be sold and how they could be sold in a tax efficient manner.
Katie has provided a complete list of her assets as follows:
- Her main residence in London is currently worth £1.7 million and was purchased for £1.1 million
- A furnished cottage in Cornwall that Katie lets out commercially and is therefore classed as a business asset. The current market value of the cottage is £400,000 and Katie acquired it for £100,000.
- Katie is the managing director of a wedding planning business called Bliss Ltd. She set up the company with £100,000 share capital four years ago and she still owns the entire share capital. She is growing bored of the business and if sold the shares are currently worth £390,000.
- Katie has a small stake in an oil company purchased as an investment just over 2 years ago. The shares cost £50,000 and are currently worth £350,000. If sold 10% of the gross proceeds are incurred as a selling expense.
- Katie has two cars detailed below:
Original cost Current Value
£ £
Porsche 120,000 80,000
Lotus Elise 24,000 44,000
Requirement: Draft a letter to Katie covering the following areas:
- Advise her on the capital gains tax consequences of the sale of each of her assets assuming that any relevant reliefs available are claimed.
- Outline any tax planning that Katie could use to reduce her capital gains tax bill particularly with relation to her new husband Rock.
There will be marks awarded for presentation (2 marks) Max word limit 1,000 words (Total 30 marks)
Question 3 : The Baldwin Family
Mike Baldwin, a higher rate taxpayer, started his own manufacturing business in 1991 when he purchased a factory for £80,000. On 31 March 2020 Mike will retire and intends to pass the manufacturing business, including the factory which is now worth £780,000, over to his son Tony who has just finished University.
Mike is worried that he may not enjoy retirement and already has an idea regarding a new business venture. There is a workshop on the market for £550,000 that Mike is considering purchasing.
Mike also owns shares in Baldwin Ltd a company set up by his wife Betty many years ago. Betty is the managing director of Baldwin Ltd and earns £55,000 per annum. Mike has never had time to get involved in Baldwin Ltd and has never been an employee of Baldwin Ltd. He became a shareholder of Baldwin Ltd 2.5 years ago buying 4% of the shares for £5,000.
Baldwin Ltd will be sold to an independent third party at the start at the end of the tax year for £570,000. This is the first capital transaction that Betty will have entered into this tax year. Betty had a 60% holding of shares in the company which cost her £40,000.
Requirement:
You are required to draft a letter to the Baldwin’s covering the following areas:
- a) Explain what relief may be available to Mike should he decide to go back into business, advising on the latest date that the purchase of the workshop should take place by to qualify for the relief.
- b) Advise both Tony and Mike of the capital gains tax consequences of the gift of the factory and of any future tax consequences for Tony if he sells the factory.
- c) Explain the capital gains tax consequences of selling the shares, outlining any reliefs available to minimise Mike and Betty’s tax liability.
There will be marks awarded for presentation (2 marks)
Max word limit 1,000 words (Total 30 marks)
Question 4 :Nina and Steve
Nina and Steve have a son called Adrian who is about to leave home. Adrian has just secured his first job and will be earning only £15,000 per year whilst training.
Nina and Steve, who are both higher rate taxpayers, are considering helping Adrian financially. Neither Nina nor Steve has made any capital disposals this year and they are discussing the disposal of the following two properties:
- Property 1: Nina’s holiday home in Devon ,UK
Nina owns a holiday home that has always been rented commercially as a business asset. The house has a market value of £150,000 and Nina purchased it for £80,000 incurring legal costs of £2,000. Nina earns rental income of £10,000 per year from the house and this is classed as business profits.
She is unsure whether to sell the house and give the net proceeds to Adrian to buy a flat or whether to gift the house to Adrian so that he receives the rental income in the future.
- Property 2: Steve’s flat in Leicester, UK
Steve inherited an investment property from his parents. Steve’s father bought the property for £50,000 and left it to Steve in his will when the property was worth £100,000. It has always been rented on a long-term tenancy and is not classed as a business asset. The property has a market value of £280,000 and if sold the estate agency fees would be 10% of the market value.
Steve could either sell the flat gifting the net proceeds to Adrian to buy a flat or he could gift the property to Adrian. If Adrian owns the investment property he would live in it and rent out the spare room for £500 per month.
You are required to draft a letter to Nina and Steve explaining the following:
The capital gains tax consequences for Nina and Steve of selling their properties
The capital gains tax consequences of gifting either property 1 or property 2 and
any reliefs available to minimise or defer the capital gains tax payable.
The income tax consequences for Adrian in respect of the rental income he would
receive if either Nina or Steve decides to gift their property to Adrian. The capital
gains tax consequences for Adrian on the future sale of the properties.
There will be marks awarded for presentation (2 marks)
Max word limit 1,000 words (Total 30 marks)
Question 5: Mr and Mrs Wilson
John Wilson was taken ill 5 years ago and has not worked for the last two years and has no source of taxable income. His wife Cheryl is the director of a travel agency in London called Air Ltd and she earns an annual salary of £128,000. All of the couple’s assets are legally owned by Cheryl.
To raise the cash to pay for John’s medical bills Cheryl needs to sell most of her capital assets and the couple require advice on the tax consequences of selling each asset.
Cheryl owns two properties; the family home and a holiday cottage in the Peak District that she has always rented commercially so that it qualifies as a business asset. Cheryl intends to sell the family home and buy a small flat for her to live in, once John has gone into hospital. Cheryl will no longer have time to manage the holiday cottage in the Peak District but in the future she is considering buying a small hotel that she could employ someone to manage for her. The current market value of a small hotel in her local area is £250,000. The properties being sold are valued as follows:
Original cost Current Value
£ £
Home 450,000 759,000
Cottage in Peak District (in UK) 120,000 245,000
Cheryl is the director and sole shareholder of Air Ltd, a company she set up ten years ago. She originally invested £50,000 share capital but a competitor has recently offered her £400,000 for the entire holding of shares. Air Ltd pays Cheryl a salary of £128,000 per annum and she is reluctant to leave such a well-paid job as the income would help to pay for John’s medical bills. In addition, her shares pay a £36,000 net dividend every year. Cheryl is considering selling the shares but staying on as a director of the company. She will use some of the proceeds to invest in her sister’s business and will buy £50,000 of unquoted shares.
Requirement: You are required to draft a letter to Cheryl and John explaining the capital gains tax consequences for Cheryl of selling each of the properties advising of any possible reliefs available.
Advise on the tax consequences for Cheryl of selling the Air Ltd shares and investing in her sister’s company.
Outline any tax planning measures that Cheryl could use to reduce her capital gains tax liability particularly with relation to her husband John.
Marks will be awarded for presentation. (2 marks)
Max word limit 1,000 words (Total 30 marks)
Question 6: Azim Khan
Azim Khan, a higher rate taxpayer, has recently been to see you as he sold a small hotel for £700,000 in March 2020. Azim’s wife Leila does not work and currently has no source of income. Azim and Leila have always lived in rented accommodation and have never acquired their own home and have never occupied the hotel. You have obtained the following information:
The hotel has been run as a business by Azim. Azim’s parents acquired the hotel in 1981 for £45,000 and Azim inherited the business from his parents on their death in June 2003. The market value of the property in June 2003 was £250,000.
Azim had continued to run the hotel since his parent’s death. This is the only business that Azim has ever been involved with. The hotel furniture will be sold, no item is currently worth more than £4,000.
Azim is considering acquiring a much larger hotel in the same town but is still undecided as to which property he will purchase. He is considering the following two premises both of which would be suitable:
OPTION ONE: Acquire a large freehold property in Azim’s name with 30 bedrooms and a self-contained flat which Azim and Leila would live in. The property is on the market for £850,000 of which £150,000 represents the living accommodation.
OPTION TWO: Acquire a 40-year lease on a large hotel with 35 bedrooms for £550,000. The cash left over could be used to buy a house, either in Azim or Leila’s name, for them to live in. They will rent out part of the house to a tenant as it will be too large for their sole occupation.
Azim is considering making an investment in his brother’s company Tan Ltd but will not be employed by the company. Tan Ltd will be issuing 10,000 newly issued ordinary shares at a price of £1 each. Azim’s brother is predicting large increases in the share price over the next few years and a high level of dividend income.
Required: Draft a letter to Azim outlining any relevant capital gains tax reliefs and covering the following:
- Explain the amount of Capital Gains Tax that will be payable by
Azim on the sale of the small hotel if he does not acquire another hotel.
- Explain the amount of Capital Gains Tax that will be payable by
Azim on the sale of the small hotel if he replaces it with either option one or with option two.
- Advise Azim on the most tax efficient way of investing in his brother’s company.
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Marks will be awarded for presentation. (2 marks) Max word limit 1,000 words (Total 30 marks) |
Solutions
Model Solution 1: The Middleton Family
To Mr & Mrs Middleton
Address
Date
Dear Mr & Mrs Middleton,
Future Investments
Thank you for your recent letter, I have considered the two options and set out my advice below.
Marks will be awarded for any of the following discussion points and there are 2 marks for presentation of a letter:
Both options will involve a new source of rental income for Kate and the crystallisation of capital gains for the Middleton’s both of which need to be notified to the Revenue by 5th October 2020 and the latest due date for any tax owed would be 31 January 2021.
Option 1:
- Main residence: gain will be covered by PPR as long as occupied throughout the period of ownership. No tax payable. If not occupied throughout ownership some gain may be chargeable on Mr Middleton as he owns the asset. (He is a higher rate taxpayer so taxed at 28% after his A/E).
- The flat will become the Middleton’s main residence and will start to qualify for PPR. Note a married couple may only have one PPR between them so the flat can be their PPR when the Surrey house stops being the PPR.
- Could consider switching PPR claim to the flat 18 months before sale of the main residence as the last 18 months of ownership are counted as deemed occupation irrespective of actual occupation.
- Gift of Holiday Home by Middleton’s
- To connected person therefore proceeds are MV
- Gain split 50 :50 between Mr and Mrs Middleton as a joint asset
- GR available as a business asset (FHL) if a joint election is made with Kate
- If no GR claim made consider rollover relief if another business asset is purchased within 3 years.
(e) Alternatively any chargeable gain may be taxed at 10% as entrepreneur’s relief is available on business assets and FHL are treated as business assets.
- Rental Income from holiday home now assessed on Kate
(a)Rent is measured on accruals basis less expenses (wholly and exclusively incurred for renting) and taxed on Kate who can use her PERSONAL ALLOWANCE.
(b)If Kate continues to rent the property commercially it will be classed as earned income as it will qualify as a furnished holiday lettings provided the conditions are still satisfied.
(c)Conditions to qualify: Available for letting for 210 days, actually let for 105 days and not let to one person for long term letting.
(d)Advantages are Kate can make pension contributions based on the income as it is included as relevant earnings for the purpose of pension contributions. Business reliefs for CGT are available and CA’s can be claimed on furniture.
Option 2
- Sale of holiday home
- Gain accrued is less than the gain on the main residence so wouldn’t elect for it to be PPR
- No PPR relief therefore gain taxable
- Joint asset so gain split 50:50
- Mr Middleton is a HIGHER RATE TAXPAYER so gain after A/E is taxed at 28%
- Mrs Middleton will be a basic rate taxpayer so gain after A/E is taxed at 18% then 28% on balance
(f)As the holiday home was rented commercially it will qualify as furnished holiday lettings. (Test being: available for 140 days and actually let for 70 days each year). IF FHL then would be classed as a business asset and the gain arising when sold could be eligible for rollover relief or entrepreneur’s relief.
Continue living in PPR: No gain will be chargeable as always been PPR. Even if elect for another property to be the PPR the last 18 months before sale will always be exempt
- Gift of the flat to Kate
- Gain when gifted will be chargeable as never been PPR
- No gift relief is available as it is not a business asset
(c)Gain charged on Mrs Middleton will be taxed at 28% with no A/E if gifted in the same tax year as the sale of the holiday home. If gifted in a different tax year she is a basic rate taxpayer and could benefit from 18% CGT rate after her A/E.
- Consider delaying the gift to next tax year when Mrs M. is a basic rate taxpayer and gets another A/E
(d)Consider using spouse NIL gain /loss rule to transfer some of flat to husband before gifting to Kate
Next year to use two A/E’s next year.
- Rental income from the flat assessed on Kate
- Taxed as non-savings income and calculated on an accruals basis
- Rental taxed on accruals basis less expenses on accruals (if revenue expenses incurred wholly and exclusively in the business of renting)
- No relief for furniture or capital assets but replacement costs allowed
- No rent a room relief available if it is NOT Kate’s residence
If I can be of any further assistance please do not hesitate to contact me again.
Yours sincerely,
A N Advisor
Appendix1: Option 1
CGT Computations
| Sale of main residence | Gift of holiday home (if gift relief is not used) | |||
| SP | 600,000 | SP | 350,000 | |
| BC | (200,000) | BC | (150,000) | |
| ¾¾¾ | ¾¾¾ | |||
| Gain | 400,000 | Gain split 50:50
as joint asset |
200,000 | |
| PPR | (400,000) | 100,000 | 100,000 | |
| ¾¾¾ | A/E | (12,000) | (12,000) | |
| Chargeable | Nil | ¾¾¾ | ¾¾¾ | |
| ¾¾¾ | Chargeable gain on Mr Middleton | £88,000 | £88,000
Mrs Middleton |
|
| Tax | Nil | At 28% | £24,640 | |
| Chargeable at 18%
to the end of basic rate band then 28% |
Appendix 2: Option 2
| Sale of holiday home | Main residence | |||
| No gain crystallising | ||||
| Split 50:50 as jointly owned | 100,000 | 100,000 | As not sold/gifted | |
| A/E | (12,000) | (12,000) | ||
| ¾¾¾ | ¾¾¾ | |||
| Chargeable gain on Mr Middleton | 88,000 | 88,000 | ||
| At 28% | £24,640 | |||
| Chargeable on Mrs Middleton at 18% to basic rate band then 28% | ||||
Gift of Flat by Mrs Middleton to Kate
| SP = MV = | 220,000 | ||||
| BC | (120,000) | ||||
| ¾¾¾ | |||||
| 100,000 | |||||
| Taxed at 28% | |||||
| No gift relief available as
not a business asset |
|||||
Assignment Question 2: Katie Rice Model Answer
Our Address
Katie Rice
Address
Date
Dear Katie
Disposal of assets to generate cash
Thank you for coming to see me last week regarding the potential sale of your property. You should be aware that you will need to notify the Revenue of any gains arising in the tax year within 6 months of the end of the fiscal year i.e. for tax year 2019/20 by 5 October 2020. Details of the gain must be entered in the tax return for the current tax year and any capital gains tax payable must be paid by 31 January after the fiscal year i.e. 31 January 2021 for tax year 2019/20……………………………………………………………………………………………………….
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