Advanced taxation - Case Study Example

Advanced Taxation Assignment Part A 0 s on the Inheritance Tax Implications to the attention of Lord Bolsover: Lord Bolsover is quite wrong in his thinking that in the event of his death, all his belongings will be divided equally between his wife and son. He is also wrong in assuming that the income and assets of the married coupe are added together for tax purposes. The fact that he has not made any will so far will make his successors liable for inheritance tax in the event of his death. Present taxation system charges Inheritance Tax on any estate worth over 300,000 (for Tax year 2007 -2008). The value of estate is arrived at by adding up the value of every thing one owns including the share in jointly owned properties. The amount of large gifts made during the last 7 years before death will also be subjected to inheritance tax. Up to the value of 300,000 the estate is covered under 'nil rate band' and no IH tax is payable. Any value over the 'nil rate band' becomes taxable at a rate of 40 percent. Inheritance tax is to be paid out before the money and belongings of the deceased can be distributed according to his/her will. Based on the above premise unless some tax planning is not done immediately, Lord Bolsover's estate would be subjected to inheritance tax. The following are some of the ways in which the incidence of Lord Bolsover's estate to inheritance tax could be mitigated. 1.1 Gift Allowances: The first available remedy is in the form of taking advantage of the gift allowances. Nil Rate Band: The 'nil rate band' is an effective saving in the value of the estate which would otherwise be subjected to inheritance tax. For calculating this exemption, the value of all properties, personal effects (paintings in the case of Lord Bolsover), cars, savings, investments and insurances will be taken into account. Transfers to spouses in the case of Married Couples: No inheritance tax is payable on the transfers made to married spouses or registered civil partners irrespective of the amount of transfers. If Lord Bolsover wishes so he can transfer his estate in the name of his wife to mitigate the incidence of inheritance tax. Exempt Gift Allowances: There are other gifts which are normally exempt from the inheritance tax like Annual Exemption of 3000 which can be carried forward for one tax year, Marriage gifts exemption of 5000 to each of the children, 2500 to each of the grand children and 1000 to anyone (these gifts are exempted subject to the condition that the gift is made before the wedding day) and exemption of small gifts made to anyone up to a value of 250 during the tax year. All these gift exemptions have the effect of reducing the value of the estate that may be subjected to inheritance tax. 1.2 Making Direct Gifts: This is another way of mitigating the incidence of the inheritance tax on the estate of Lord Bolsover. However for using this method of tax avoidance there are two hitches which Lord Bolsover has to consider: He should live at least for 7 years to make the gifts exempt from tax He cannot have access to the monies gifted by him on his own accord. The important point to note here is that any gift made directly or into an absolute trust over and above the exempt gift allowance will be deemed as 'Potentially Exempt Transfers (PET) for a period of 7 years and until this period of 7 years the person making the gifts should remain alive to make the gifts eligible for exemption from inheritance tax. However the law allows the charging of the inheritance tax pro-rata depending on the year of death after the gifts or transfers are made, subject to the nil rate band of 300,000. This method of taxing pro-rata is known as Taper Relief which reduces the tax incidence by 20 percent every year after an initial period of 3 years. That means the reduction of tax rate will start from the fourth year before death onwards. But there are several other considerations like the time at which Lord Bolsover wants the beneficiaries to get the gifts, change in the circumstances of the beneficiaries, death o the chosen beneficiary or even change in the mind of Lord Bolsover himself that deter adopting this method. Once something is gifted to someone it becomes irreversible. 1.3 Gifts to Trust: The best possible option that Lord Bolsover can consider as a tax planning method is to form suitable trusts and place the entire estate with the trust so that all the wealth remain with the trust and can be distributed by Lord Bolsover as and when he desires. Two forms of trusts can be formed depending on the intention of Lord Bolsover to retain control over the capital and income of his estate. They are 'Flexible Trusts' and 'Loan Trusts'. Each has advantages of its own. Flexible Trusts have the features of: After gifting the monies, control can be retained as to when and to whom the gifts are to be distributed The investments of the monies can be controlled Money gifted away will be treated as 'Chargeable Life Time' Transfer (CLT) and will fall outside of the estate in the 7 years period There is a possibility that beneficiaries can be changed at any time However the donor will not have access to the monies gifted to the trust Loan Trusts on the other hand the following features: Instead of gifting the estate value will be loaned to the trust "This type of plan could be suitable for those people who wish to take steps to mitigate inheritance tax but still wish to retain access to their original capital" (Skipton Financial Services) There is a possibility that control can be kept and income can be received up to the original loan value The growth on the investments will be outside the estate value It must be noted that gifts to discretionary trusts would be subjected to inheritance tax at 20 percent. However if the donor does not survive for 7 years then the tax would be payable at the full rate of 40 percent. 1.4 Discounted Gift Scheme: Discounted gifts are a way of giving the money away to avoid the incidence of the inheritance tax and at the same time the donor can retain the right for a regular predetermined income. Moreover such transfers become eligible for a discount in the inheritance tax depending on the age and the income level the donor wanted to retain. Obviously the remainder of the gift falls outside the estate value after the ceiling period of 7 years. 1, 5 Life Assurance Policy: Lord Bolsover can consider insuring the liability for inheritance tax by using a Whole of Life Policy which may be a cost effective way of providing for the eventual bill and the procedure is also reasonably simple to set up. However considering the age and physical conditions of Lord Bolsover it is to be seen whether this method could work and at what cost. 1.6 Deeds of Variation: Many a times individuals write wills without exactly knowing the implications of the inheritance tax and as a result the liabilities for avoidable inheritance tax are incurred. Under such circumstances the deed of variation is a viable means of overcoming the problem. The deed of variation allows the change in the beneficiaries under the will or within the rules of intestacy if there is no will after the individual's death. The deed of variation can be used as a retrospective tax planning device. However it should satisfy the following conditions: The deed should have been executed within 2 years of death The deed must be signed by all the original beneficiaries and the beneficiaries should also relinquish their entitlement to the inheritance under the will The signing should be a voluntary act and not for any consideration 2.0 Valuation of Assets for Inheritance Tax Purposes: For the purposes inheritance tax purposes the belongings of Lord Bolsover would be as follows: General: Generally for inheritance tax, the assets and belongings are to be valued in the open market value. The open market value of an asset is the price it might reasonably fetch if it was sold on the open market at the time of the transfer of that asset. Private Farming Land: Normally open market value has to be adopted for the farm lands. 50 percent of the market value of the farming land will be included in the value of the estate. The total value of the land cannot be discounted in full as the farming land is not in the vacant possession of Lord Bolsover and also since the possession cannot be obtained in 24 moths (lease periods being extending from 10 to 60 year).These two conditions need to be fulfilled for discounting the full value. Castle and grounds held on freehold, Paintings, Cars including Vintage car, Flat in Paris: The value of these belongings is included in the estate of Lord Bolsover at the "prices these might reasonably fetch in the market at the time of occasion (lifetime gift or death). This is known as the 'open market value'. Valuation of Quoted Shares: The quoted shares are to be valued on the basis of the price quoted in the London Stock Exchange as on the date of the death. If the stock exchange is closed on that day, the price as per the previous working day can be taken. The share price is to be reckoned as the least in the range of the price quoted plus one quarter of the difference between the upper and lower range of the prices. This is known as quarter up price. If any dividend on the shares is due and payable by the companies, then such dividend should also be included in the value of the shares. In case if the shares are sold within one year of death, at a price lower than at which the inheritance tax is paid, a relief for the loss on sale of shares can be claimed. Personal assets: The value of all these assets will be included as such for the purposes of levy of inheritance tax valued at 'open market value'. Bank Accounts: The balance in the account as shown by the books of the bank on the date of transfer or death will be taken as the value of bank accounts. Shares in Gladrags Limited: Value of Shares in Gladrags Limited, being unquoted shares held in the family trading company would be eligible for a 100 percent exemption from inclusion in the estate of Lord Bolsover. Interest in the family discretionary trust and in the Possession Trust: Lord Bolsover's interest in the family discretionary trust and the possession trust should be valued on the basis of 'open market value' and included in his estate for levying inheritance tax. 3.0 Treatment of Income: Dividends From Gladrag Limited/Dividend Income from Quoted shares: The divined income received from the Gladrag Limited as well as other quoted shares would constitute an income taxable. This income would be included in the total income statement and subjected to tax at the appropriate rates. No tax would be payable, if current income of the person is to be applied with the basic rate of tax. Otherwise tax is payable at 25 percent. Bank Interest: This income is subject to Tax. However would be eligible for some deduction. Part B To Lady Bolsover Dear Madam Re: Your Query regarding Certain Taxation Issues With reference to your query regarding the issues connected with taxation in the following cases, the item wise reply is appended below for your information: Your proposal to dispose off certain quoted shares from your investment portfolio Other Taxation issues 1.0 Disposal of Shares and Capital Gains Tax: Capital Gains arising on the disposal of a wide range of assets including Quoted shares are attracted to Capital Gains Tax. Presently the Capital Gains Tax is payable at 20 percent of the total gain made when the taxable incomes and gains are below 33,000 and at 40 percent or more when it exceeds this limit. The tax is however subject to an annual allowance of 8,000fo tax-free gains. Your domicile status for the purpose of Capital Gains Tax would be resident of UK and any gains from the disposal of the quoted shares would be added in your income for the year in which the sale is effected and would be charged to capital gains tax at the rate indicated above. In the case of shares in a company there is a disposal for capital gains tax purposes where a person receives capital payments in respect of their shareholding or interest held in the paying company. Like any other capital gains tax computations a chargeable gain on the disposal of he company shares is arrived at by deducting the cost of the shares (adjusted for inflation as appropriate) from the net consideration received for the disposal of the shares. The calculation of the value of shares is not complicated for capital gains purposes. However there are special provisions governing the valuation of rights and bonus shares. In the case of Bonus shares that the original cost is diluted by dividing the cost of acquisition with the total number of shares including the bonus shares and the date of purchase will be reckoned as the original date of purchase. Under Rights issue the procedure for calculation is the same as that of bonus issue except that an allowance is to be made for the amount paid to acquire the additional rights. 2.0 Other Taxation Issues: Please note that unless a written will is executed indicating the preferences for distributing your wealth on death, there would be the incidence of the inheritance tax on the wealth you leave after your death. The inheritance tax would be payable from the value of your estate and the remainder would only go to the beneficiary. Domicile for Inheritance Tax Purposes: For the purposes of IHT the domicile is determined in a way other than for income tax purposes. The residents of UK irrespective of whether long term or recent resident is charged for the worldwide assets. Any person who makes a transfer for IHT purposes either by way of lifetime gift or on death will be deemed to be domiciled in UK for the purposes of IHT if they were: UK domiciled at any time within three years immediately before the death or transfer OR Resident in the UK in at least 17 out of the 20 income tax years ending in the year in which transfer takes place. It should be noted that anyone leaving the UK permanently could retain UK domicile for at least a period of three years possibly longer after departure. Assuming that soon after your marriage in 1978 with Lord Bolsover, you're residing continuously in UK, then you satisfy one of the conditions that 'resident in UK for at least 17 years out of the 20 income tax years ending in the year in which the transfer takes place'. Now that you have become resident of UK for the purposes of IHT it would be advisable to do a proper tax planning by making a suitable will specifying gifts/transfers to trusts so that you can avoid unnecessary incidence of Inheritance tax on your estate. 3.0 Double Taxation in Respect of Inheritance Tax on the House Property in Portugal: For your information, UK has a double taxation treaty with more than 100 countries including Portugal covering various sources of income and capital gains. However UK does not have any arrangement with Portugal for the taxes on gifts, estates and Inheritances. Hence the rental income from the property in Portugal would be eligible for tax relief in Portugal. Whereas the inheritance tax would be applied in UK as per your domicile status discussed above. For the purpose of inheritance Tax the following of your wealth would be included; Property in Portugal: Because of the Domicile status the value of the property in Portugal would be included in your estate for IHT purposes. As explained earlier although you can claim double taxation relief for the rental income from this property, the value would automatically be included in the total estate value. A proportion of the amount of 200,000 spent on the improvement of the property can be adjusted against your income but not the amount of 20,000 spent on the furniture. Shares in Gladrags Limited: These would be exempt from inclusion in the wealth for the purposes of inheritance tax being unquoted shares representing a family business. Jewellery and Value of Quoted Shares: Both of these assets would be valued at open market price and included in the estate value for inheritance tax purposes. Since the quoted share does not represent business assets no exemption can be claimed from inheritance tax for this asset. 4.0 Dividend Income from Gladrag Limited: The divined income received from the Gladrag Limited would constitute an income taxable. This income would be included in your total income statement and subjected to tax at the appropriate rates. If you are a basic rate tax payer then this income would not be charged to tax. If your income exceeds the level for the basic rate of tax then tax would be payable at 25 percent. Word Count: 2693 Reference: Skipton Financial Services Will You Be giving Generously to the Taxman Read More