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chapter 4 (Tax) and a Past paper problem

I

Ivanhoe

Member
At the outset, I apologise for the long list of some basic questions pertaining to chapter 4. I would be glad if some one could shed some light.


Page 2
Tax relief is limited to 10% and is only available to taxpayers born before
6 April 1935.
[/I]
What does tax relief is limited to 10% mean? Also, 10% of what? Does the column of "additional married mean that those extra allowances are applicable for people who are born before 1935 and are married?

Page 3
Interest is taxed at 10%, 20% and 40%.
(*) The 10% rate is a starting rate for savings income up to a limit. If non-savings
income is above this limit then the 10% starting rate for savings will not apply.
The tax rates applicable to dividends are 10% ordinary rate, the 32.5% dividend
upper rate and the dividend additional rate of 42.5%.

Could you please explain what this means?


Inheritance tax

Where a donor of a lifetime gift dies within seven years of making the gift, IHT
may be due on the gift. The full rate of tax is reduced depending on the interval
between the gift and the date of death. Such transfers, where there is no
immediate liability to IHT, are known as “potentially exempt transfers”.

Any amount in excess of 3000 will be taxed at 20% anyway, isn't it? Or does this para pertain to those amounts which are within 3000 and where the donor dies within 7 years of gifting these?


Capital Gains

For 2012/13, the first £10,600 of an individual’s net gains realised during the tax year are free of CGT. The excess is taxed as if it was the “top slice” of income,at the rates that apply to savings income and for 2012/13 it is taxed at 28%.



Is there a separate tax structure for saving income? Where did they get 28% from? I did not quite understand this para.

Tax on Money market instruments-

For individual basic-rate taxpayers tax on money market instruments and deposits is due at the rate of 20%. (A lower rate of 10% applies to savings income but only when the individual’s non-savings income is less than £2,560.)

How is this 2560 and 2790(in the table on page 3) related? What if the non saving income is between 2560 and 2790? I am not sure of what precisely saving rate means.


UK Equities-Franked Income The core reading and the acted text on Page 14

What does tax credit mean? Have they assumed net dividends to be 90% of gross? what does it mean? How did they arrive at an additional tax of 22.5% of gross dividend in that example? Could you please explain me the concept of franked investment income given on that page?


Sep 2013 Q1 Part iv
Is the living accomodation income taxed at 40% since the investor falls in the 40% tax bracket?
Could you explain the tax calculation for the dividend income and the offhsore land account income?

Also, what is personal allowance deducted from ?(In Mrs. X's tax calculation it is deducted from her offshore income?


Could you please help? I am struggling with this chapter.:)
 
Hi, I understand where you are coming from. This is not a nice chapter, but there have been some questions in the past that require detailed knowledge of the rates and allowances etc.


Page 2
Tax relief is limited to 10% and is only available to taxpayers born before
6 April 1935.

What does tax relief is limited to 10% mean? Also, 10% of what? Does the column of "additional married mean that those extra allowances are applicable for people who are born before 1935 and are married?


I assume it means that if you pay tax at the marginal rate of (say) 20%, and you are maried, AND you were born a long time ago, you can claim up to 10% relief back (but not the full 20% you have paid.)



Page 3
Interest is taxed at 10%, 20% and 40%.
(*) The 10% rate is a starting rate for savings income up to a limit. If non-savings
income is above this limit then the 10% starting rate for savings will not apply.
The tax rates applicable to dividends are 10% ordinary rate, the 32.5% dividend
upper rate and the dividend additional rate of 42.5%.

Could you please explain what this means?

I think it means that the 10% rate is scrapped, but may still apply if your only income is savings income (not salary/earnings). The 32.5% is the sum of the theoretical tax paid on the dividend tax credit (10%) plus the additional tax paid by higher rate taxpayers of 22.5%. The 42.5% may relate to the "additional rate" tax payers - ie those earning more than 150k, who used to pay 50%, and would therefore pay an additional 32.5% on the dividends. their rate is now reduced to 45%, so I guess that the additional has dropped to 27.5% rather than 32.5%. but CR has not been updated.


Inheritance tax

Where a donor of a lifetime gift dies within seven years of making the gift, IHT
may be due on the gift. The full rate of tax is reduced depending on the interval
between the gift and the date of death. Such transfers, where there is no
immediate liability to IHT, are known as “potentially exempt transfers”.


You can gift your wealth to your kids. But if you die within 7 years, the revenue will claw some inheritance back based on the size of the assets you transferred. After 7 years, its free.

Any amount in excess of 3000 will be taxed at 20% anyway, isn't it? Or does this para pertain to those amounts which are within 3000 and where the donor dies within 7 years of gifting these?


Capital Gains

For 2012/13, the first £10,600 of an individual’s net gains realised during the tax year are free of CGT. The excess is taxed as if it was the “top slice” of income,at the rates that apply to savings income and for 2012/13 it is taxed at 28%.

I think the top slice is out of date. capital gains used to be taxed at the marginal rate of income tax - ie the top slice of your earnings. But its been simplified now and a higher rate taxpayer pays 28%. (even if top slice of income is at 40%)


Is there a separate tax structure for saving income? Where did they get 28% from? I did not quite understand this para.

Tax on Money market instruments-

For individual basic-rate taxpayers tax on money market instruments and deposits is due at the rate of 20%. (A lower rate of 10% applies to savings income but only when the individual’s non-savings income is less than £2,560.)

How is this 2560 and 2790(in the table on page 3) related? What if the non saving income is between 2560 and 2790? I am not sure of what precisely saving rate means.

I think they may be the same thing, but one has been updated to the current year, and one hasnt. In the new core reading for next year, both nbumbers are the same : 2,880




UK Equities-Franked Income The core reading and the acted text on Page 14

What does tax credit mean? Have they assumed net dividends to be 90% of gross? what does it mean? How did they arrive at an additional tax of 22.5% of gross dividend in that example? Could you please explain me the concept of franked investment income given on that page?

Its complex history, and probably not necessary. Politicians tampering with rates to make it harder for non taxpayers and pension funds to reclaim any "tax credit" (it was reduced from 20% to 10% to prevent this). Then it was further tampered-with, and now noone can reclaim anything! So its irrelevant now. The 22.5% was likewise an accident of history, as politicians increased it to get higher rate taxpayers to pay a bit more than they did.


Sep 2013 Q1 Part iv
Is the living accomodation income taxed at 40% since the investor falls in the 40% tax bracket?


Yes

Could you explain the tax calculation for the dividend income and the offhsore land account income?

Offshore land: pays 1200 but 400 deducted at source, so only 800. Split between husband and wife as joint ownership so 400 each. Husband taxed at 40% but wife expempt as the allowance against income is not used up.
Dividend: net div received (split) is 1250. So gross is 1388.9, so additional tax at 22.5% is 312.5

Also, what is personal allowance deducted from ?(In Mrs. X's tax calculation it is deducted from her offshore income?

Personal allowance goes against whatever you can. MrX uses his when salary is added, so none left. But MrsX hasnt got salary and so can use allowance here.


Could you please help? I am struggling with this chapter.

You are not alone!
 
Thank you for your responses professor! Things are much clearer now. By the way, the upper dividend rate is 37.5%. I mentioned it erroneously as 42.5%.The core reading is correct and I did understand the concept of franked dividend income and how the rates tie in with the income tax rates.

For the overseas investment income in the exam problem, that amount is not converted to pounds. Or am I making some silly mistake here?:)

By the way, some portions of the syllabus could have been presented better. I had a similar feeling for all earlier papers as well!:)
 
Good point on the overseas account. The examiner has split 800 between the two people. I suggested that this was the 1200 less the 400 withholding tax, but it is more likely to be 1200/1.5 = 800 split two ways. the assumption is that the withholding taxes can be reclaimed.
 
If they are assuming that witholding taxes will be claimed where is it allowed for in the final tax payment.How did they arrive at the tax amount of 160 and the tax credit of 133.33. I was trying to arrive at these in the same manner as the one used to calculate the tax credit for the franked dividend income? I was unable to arrive at the above mentioned numbers though. Could you please help?
 
If they are assuming that witholding taxes will be claimed where is it allowed for in the final tax payment.How did they arrive at the tax amount of 160 and the tax credit of 133.33.

My thinking is that 1200/1.5 is 800, which is divided 400 for each of the husband and the wife. The husband is a 40% taxpayer and so pays 40% of 400 = 160 on his share. The witholding tax of 400 can be reclaimed. this is 400/1.5 = £266, which means half of that goes as a reclaim for the husband (=£133)


I was trying to arrive at these in the same manner as the one used to calculate the tax credit for the franked dividend income? I was unable to arrive at the above mentioned numbers though. Could you please help?


Hope this helps
 

My thinking is that 1200/1.5 is 800, which is divided 400 for each of the husband and the wife. The husband is a 40% taxpayer and so pays 40% of 400 = 160 on his share. The witholding tax of 400 can be reclaimed. this is 400/1.5 = £266, which means half of that goes as a reclaim for the husband (=£133)

I understand what you are saying. I was trying to map this to the acted problem mentioned in this chapter though. That was about the Japanese subsidiary paying dividends to the parent company. I was trying to compare the basic principles.

In that problem, the parent company pays tax on the dividends received of 2 million net of witholding tax of 0.2 million retained by the Japanese subsidiary.

Then the double taxation agreement meant that they would take credit for the tax paid on this slice of earnings abroad. We can ignore this aspect here, I suppose.

And finally, the witholding tax deduction is allowed for.

So, my question is whether Examiner's should have deducted the income tax on the actual amount received net of witholding tax and then taken credit for the witholding tax?

Also, have they considered 40% since the interest rates are 10%, 20% and 40% (as given on page 3 of the chapter)? Had these been overseas dividends, these should these be assumed as net (i.e 90% of gross)?

Regards,
 
Last edited by a moderator:
I understand what you are saying. I was trying to map this to the acted problem mentioned in this chapter though. That was about the Japanese subsidiary paying dividends to the parent company. I was trying to compare the basic principles.

In that problem, the parent company pays tax on the dividends received of 2 million net of witholding tax of 0.2 million retained by the Japanese subsidiary.

And finally, the witholding tax deduction is allowed for.

So, my question is whether Examiner's should have deducted the income tax on the actual amount received net of witholding tax and then taken credit for the witholding tax?


I have limited experience with withholding taxes - the ActEd problem was designed around the examiners past paper question (which I think is unlikely to be repeated, but you never know). In the past paper, the company got a UK corporation tax rebate due to the double tax treaty, based on the overseas corporation tax paid on the dividend by the subsidiary(as you say). It was then able to reclaim the withholding tax that was deducted by the foreign government from the dividend payment, which I think is the normal treatment. In the second example, the personal tax example, there is no corporation tax. So the first part falls away. But the double tax treaty allows any withholding tax deducted by foreign government to be either reclaimed or set off against UK income tax - normally reclaimed I believe. Hence the treatment in the personal tax example.




Also, have they considered 40% since the interest rates are 10%, 20% and 40% (as given on page 3 of the chapter)? Had these been overseas dividends, these should these be assumed as net (i.e 90% of gross)?

Not sure I understand this last para. ??
 
I meant to ask as to why they have considered 40% as the tax rate? Is it because the investor falls in that bracket and the tax rates on interest income is 10%,20% and 40% (as given on page 3 of the chapter)?

Also,Had these been overseas dividends, should the amount of 1200-400 i.e 800 francs be considered as net dividends received, (as we consider for dividend payments from UK companies)? So I would have to pay an extra tax 25% of net dividends (i.e 25% *400 francs /1.5) and then claim the deduction for witholding tax?

Regards,
 
I meant to ask as to why they have considered 40% as the tax rate? Is it because the investor falls in that bracket and the tax rates on interest income is 10%,20% and 40% (as given on page 3 of the chapter)?


Yes - investor is a 40% higher rate taxpayer.



Also,Had these been overseas dividends, should the amount of 1200-400 i.e 800 francs be considered as net dividends received, (as we consider for dividend payments from UK companies)? So I would have to pay an extra tax 25% of net dividends (i.e 25% *400 francs /1.5) and then claim the deduction for witholding tax?



I doubt the higher rate 25% of net divs would work on overseas divs, because there is no "tax credit" as there is with a UK dividend. The UK system is an imputation system, allowing you to use the tax credit to offset basic income tax on the div. Not so with other systems. I would assume that you pay 40% on the divs reveived, but that withholding tax should be reclaimable (but in my experience it is virtually impossible to get the withholding tax back - a letter to each tax jurisdiction, confirmed by your SIPP provider, in every language under the sun ....)


Regards,
 
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