j01 personal tax study guide

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Copyright 2010. All rights reserved. Intellego Limited.

Intelligent Learning from Intellego

www.intellego.co.uk | +44 (0)20 8977 8744

Intellego Revision Handbook

J01 Personal Tax


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Page 2 Copyright 2010 All rights reserved. Intellego Holdings plc


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Copyright 2010 All rights reserved. Intellego Holdings plc Page 3

Revision Handbook

The information contained in these notes is intended solely as focused

revision material, to be used in addition to other material to highlight key

elements.

It is recommended that a full study be made of the examination syllabus to

ensure a proper understanding is achieved of the aims, structure and

content of the paper.

We have made every effort to ensure that the information contained in the

notes is correct. We do not accept liability of any kind for the information

contained herein, nor for any conclusion drawn from it by any party, nor from

any use to which the information or conclusions may be put. We do not hold

the information out to be anything other than general guidance materialwhich should be checked before using as the basis for any action or advice.

Responsibility for loss occasioned to any person acting or not acting as a

result of the information in these Revision Notes cannot be accepted by us.

All Rights ReservedNo part of these notes may be reproduced or transmitted in any form or by

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Intellego Holdings plc 2010, 1st Edition,

Published by: Intellego Group,

Livingston House, 2 Queens Road, Teddington, Middlesex, TW11 0LB.


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1.Table of contents1. Table of contents............................................................................5

2. The basic structure of the tax system and self-assessment.....11

HMRC and main taxes that apply to individuals .....................11

The Budget..................................................................................11

Main personal taxes ..................................................................12

Income Tax .................................................................................12

Employed or self-employed .....................................................15

Capital Gains Tax.......................................................................16

Inheritance Tax...........................................................................18

Self-assessment...........................................................................20

Payments.....................................................................................21

PAYE system................................................................................21

Revision exercise 1........................................................................23

Revision Answers ........................................................................24

3. Income Tax ....................................................................................27

Application of total income after taking deductions.............27

Tax computations ......................................................................28

Share schemes and share option schemes..............................29

Share Incentive Plans (SIPs) ......................................................30

Savings Related Share Options Schemes (SAYE) ..................31

Company Share Option Plans (CSOPs) ..................................32

Enterprise Management Incentives (EMIs).............................33

Employee Share Ownership Trusts (ESOTs)..............................34

The main rules of allowable deductions against income.......35

Loans............................................................................................35

Charitable giving .......................................................................36

Capital allowances ...................................................................37

Tax relief on pension contributions ..........................................38

Tax treatment of employee benefits ......................................39

P11D employees ........................................................................41

Fuel benefit .................................................................................43

Private medical insurance and other insurance premiums.44

Free use of assets .......................................................................44


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Beneficial loans.......................................................................... 45

Miscellaneous ............................................................................ 46

Personal allowances and reliefs.............................................. 47

Tax rules for minors..................................................................... 49

How income affects entitlement to child and working tax

credit........................................................................................... 51

Child Tax Credit ......................................................................... 53

Revision exercise 2 ....................................................................... 57

Revision Answers........................................................................ 58

4. National Insurance....................................................................... 61

Main Structure Class 1................................................................. 61

National Insurance payments................................................. 63

Contract in or out...................................................................... 63

Reduced rate for married women ......................................... 63

Collection................................................................................... 64

Rules for company directors.................................................... 64

Overseas aspects of National Insurance............................... 66

Place of business in the UK....................................................... 67

Earnings in foreign currency .................................................... 67

Special categories of employment........................................... 68Examiners.................................................................................... 68

Student employees................................................................... 68

Temporary or agency workers................................................. 69

Class 3............................................................................................ 70

National Insurance credits.......................................................... 71

Revision exercise 3 ....................................................................... 73

Revision Answers........................................................................ 74

5. Capital Gains Tax......................................................................... 77

Chargeable assets....................................................................... 77

Types of disposal........................................................................ 78

Shares, unit trusts and other investments ............................... 78

Exemptions.................................................................................... 82

Reliefs............................................................................................. 83

Principal residence.................................................................... 83

Business asset rollover relief...................................................... 85


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Incorporation relief ....................................................................86

Gift holdover relief .....................................................................86

Entrepreneurs relief ....................................................................87

Enterprise Investment Scheme.................................................88

Gifts ..............................................................................................89

Separation and divorce............................................................89

Deferred consideration.............................................................90

Life assurance policies ..............................................................90

Calculating the gain ....................................................................91

Payment dates...........................................................................92

Losses ...........................................................................................93

Enterprise Investment Scheme ...................................................98

Revision exercise 4......................................................................100

Revision Answers ......................................................................101

6. Tax treatment of investments....................................................104

Savings and income ..................................................................104

Cash deposits ...........................................................................104

Taxation of savings income....................................................104

National Savings & Investments.............................................106

Fixed interest securities............................................................107Permanent Interest Bearing Shares (PIBS).............................107

Taxation of dividends on shares (including investment trusts),

unit trusts and OEICs...................................................................108

Taxation of dividend income.................................................108

Tax exempt products .................................................................109

ISAs .............................................................................................109

Dividend income within an ISA ..............................................109

Child Trust Funds.......................................................................110

Taxation of investment property ..............................................111

Qualifying and non-qualifying life policies..............................112

Income drop below HRT threshold following retirement....113

Calculating a gain...................................................................114

Taxing the gain.........................................................................115

Calculating the tax..................................................................116

Offshore policies.......................................................................117


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Annuities...................................................................................... 119

Enterprise Investment Scheme................................................. 120

Main conditions for EIS relief .................................................. 120

Venture Capital Trusts................................................................ 121

Qualifying Investments ........................................................... 121

Revision exercise 5 ..................................................................... 122

Revision Answers...................................................................... 123

7. Inheritance Tax........................................................................... 126

Basic principles........................................................................... 126

To whom does IHT apply?...................................................... 127

Nil rate band............................................................................ 128

To which transactions does IHT apply ? ............................... 130

Excluded property................................................................... 131

Cumulation principle .............................................................. 132

Calculation of tax liability....................................................... 132

Valuation of transfers .............................................................. 136

Related property..................................................................... 137

Timing ........................................................................................ 138

Grossing-up rule....................................................................... 138

Life policy values ..................................................................... 139Interests in settled property.................................................... 140

IHT on discretionary trusts ....................................................... 142

Exemptions and reliefs............................................................... 143

Exemptions ............................................................................... 143

Annual exemption................................................................... 144

Reliefs ........................................................................................ 146

Reservations and associated operations............................... 150

Associated operations............................................................ 152

Accounting and administration............................................... 153

Payment dates ........................................................................ 154

Gift and Loan Trust .................................................................. 156

Pension schemes..................................................................... 156

Life assurance.......................................................................... 157

Revision exercise 6 ..................................................................... 159

Revision Answers...................................................................... 160


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8. Residence and Domicile ...........................................................163

Introduction ..............................................................................163

UK residence.............................................................................164

Domicile ....................................................................................165

The remittance basis ...............................................................167

When an individual becomes a UK resident........................167

Emigration.................................................................................168

Double taxation agreements.................................................168

Inheritance Tax.........................................................................169

Revision exercise 7......................................................................171

Revision Answers ......................................................................172

9. Mock exam .................................................................................175

Mock Exam Answers...................................................................182

10. Tax tables...............................................................................197

Main tax credits ..........................................................................198

National Insurance .....................................................................199

Class 1 Employed..................................................................199

Class 2 Self-employed ..........................................................200

Class 3 Voluntary...................................................................200

Class 4 Self-employed ..........................................................200Capital Gains Tax .......................................................................200

Rates of tax ...............................................................................200

The charge to tax ....................................................................200

Annual exemption ...................................................................201

Chattels exemption .................................................................201

Entrepreneurs relief ..................................................................201

Inheritance Tax ...........................................................................202

Rates of tax on death transfers..............................................202

Rates of tax on lifetime transfers............................................202

Main exemptions......................................................................202


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2.The basic structure of the tax systemand self-assessment

HMRC and main taxes that apply to individuals

Her Majestys Revenue and Customs (HMRC) are the body

responsible for the collection of tax revenue within the UK. As

everyone is aware, they issue coding notices for each financial

year starting on 6 April. Dependent upon the detail contained

within these notices, we all pay greater or lesser amounts of tax.

For most of us, this is a generally simple procedure with the tax

due each month being deducted through the PAYE (Pay As

You Earn) system, but more than 8 million individuals in the UKare required to complete the self-assessment process and

submit this to HMRC.

The role of HMRC is not merely that of tax collector; it is also

considered to be a government service to assist members of the

public with explanations of their tax affairs and liabilities and

also to educate and provide information on the system and

how it works.

The Budget

Each year the tax rules are determined by the Chancellors

Budget which historically was announced in March, before the

start of the new tax year. In more recent times, there has been a

move to the use of the Pre-Budget Report delivered in the late

autumn of the previous year. This is to highlight possible changes

and major reforms that may need debate and legislation in the

enactment, thereby giving the government of the day more

time to put in place the required implementation procedures.

The new tax year starts on 6 April and this is the date from which

most new proposals or changes in rates will be implemented,


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although it is worth noting that the budgetary changes do not

become law until the Finance Act is passed. The Finance Bill is

put before Parliament following the Budget, and it is not until this

process is completed that the Act can be passed into

legislation.

Income Tax itself was originally introduced as a temporary tax

to raise funds to fight the French forces under Napoleon. It was

originally repealed a year after Napoleons defeat at the Battle

of Waterloo but was re-introduced in 1842 to deal with a

growing deficit at the exchequer resulting from the social

changes of the early 1800s. It was intended to be applied for a

period of three years, with a further possible extension of two

more, but has remained on the statute books ever since. Each

year the right to claim tax expires on 5 April and, until the

Finance Act becomes law, taxes are collected under the

Provisional Collection of Taxes Act 1913.

Main personal taxes

HMRC are responsible for the collection of all the tax revenue in

the UK. In this study guide, we will be concentrating on the four

main personal taxes as they apply to individuals and

investments.

Income Tax National Insurance Capital Gains Tax Inheritance Tax

Income Tax

Income Tax applies to both earned and unearned income, as

the name suggests, but not all income is taxable.


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Taxable income

Taxable income would generally include the following:

Income from full, part-time or temporary employment; Additional benefits from employment such as company

cars, fuel allowances for private use of a vehicle, private

medical insurance or a season ticket for travel. Usually

these are referred to as benefits in kind' or P11D benefits;

Income from self-employment as a sole trader orpartnership income;

Pension income from the state, company and personalpensions;

Interest on deposit savings not including PEPs, ISAs andsome National Savings products;

Investment income from shares not held within a PEP orISA.

Also taxable are state benefits such as:

Bereavement Allowance; Incapacity Benefit from week 29; Employment and Support Allowance; Carers Allowance; Jobseeker's Allowance; Statutory Sick Pay, Maternity, Paternity and Adoption

Pay;

Widowed Parent's Allowance.

Other taxable income is:

Rental income in your own home above 4,250 orincome from a second property such as a buy-to-let

investment;

Income arising from a trust.Non-taxable income

Examples of non-taxable income would be:


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Dividends or interest held within PEPS and ISAs, NationalSavings Certificates;

Proceeds from gambling or Premium Bonds.

The most common non-taxable state benefits are:

Disability Living Allowance; Attendance Allowance; Lump sum Bereavement Payments; Pension Credit; Free TV licence for over 75s; Winter Fuel Payments and Christmas Bonus to pensioners; Housing Benefit; First 28 weeks of Incapacity Benefit; Income Support certain payments; Child Benefit; Guardian's Allowance; Maternity Allowance; Industrial Injuries Benefit; Severe Disablement Allowance;

War Widow's Pension.

Allowances

Each individual also has a Personal Allowance to set against

their income which they are allowed to earn tax free. In

addition to this, the over 65s receive the higher personal

allowance, which is raised further at age 75.

There were also two levels of married couples allowance for

those with a partner aged 65 and over and a further higher

level for 75+ but as the lower level of allowance was dependent

on one partner having a date of birth before 6 April 1935, this

has now become redundant.

For eligible individuals, there is also a Blind Persons Allowance.


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Employed or self-employed

The question of whether someone is employed or self-employed

is not a matter of personal choice. It will be decided by a

number of factors taken into account by the Inland Revenue.

The initial test will be to see if an individual is working under

contract of service, which would mean they are an employee,

or a contract for services, which would generally indicate self-

employment.

There is no legal definition of these two terms. HMRC base their

decision on the reality of the circumstances rather than on whatthe individual parties say their relationship is.

A test of employment would normally be based on whether or

not the individual is given set tasks during a set number of hours

and whether they are under the management control of others

in the workplace.

In determining self-employment HMRC will consider if the

individual is taking the financial risk on non-payment or bad

debt, the ability to substitute other workers in the event of

absence, working on a fixed-price contract, correcting

unsatisfactory work at their own expense and, most importantly,

working for a number of different people or companies.

It has also been challenged in recent years that individuals

working on long-term contracts for the same company should

be treated as employees for Income Tax and National

Insurance purposes. This would be where an individual leaves a

position within a company and then returns at a later date as a

consultant to the same company fulfilling the same or similar

function. This legislation is more commonly known as IR35, and

individuals who are concerned regarding the impact of such


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legislation are invited by HMRC to submit contracts to it if they

are unsure of the status of the contract.

Capital Gains Tax

Capital Gains Tax (CGT) is a tax on the profit or gain made

when an individual disposes of or sells an asset. Normally this

applies when an asset is held for a period of time, such as a

painting that rises in value and whose subsequent sale

proceeds exceed the purchase costs. Tax is payable on the

difference between the original purchase price and sale

proceeds.

A disposal is not always a sale. It may be as a result of a gift or

transfer to another party, or in exchange for other goods or

services of value. A disposal may also come about as a result of

loss, such as an asset being destroyed by fire. In this case it

would be the actual value of the compensation received rather

than the value before the asset was destroyed which may be

higher or lower than the compensatory amount.

If a transfer is a gift to your spouse or partner, this will not give

rise a charge for CGT. However, if a gain is subsequently realised

at a future date, the spouse will pay tax based on the entire

period of ownership.

Assets liable to CGT

In simple terms, most assets, whether they are in the UK or

overseas, are potentially liable to pay CGT on a gain.

Most chargeable capital assets are liable to Capital Gains Tax

when they are sold or disposed of. However, if the asset being

disposed of is connected with the individuals normal

employment, such as a property development, it will be

chargeable to Income Tax on the individual (or Corporation Tax


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if a limited company). CGT will not apply. For individuals, the

following is a list of the most common types of chargeable

asset.

Property, including land, buildings and leases, such as asecond home that has been rented out or a shop or

business premises. An individuals main residence is not

subject to CGT as it usually qualifies for Private Residence

Relief, meaning there is no tax to pay. This is covered in

the later chapter on CGT.

Shares, units in a unit trust and similar investments areliable to Capital Gains Tax. Gains or losses are calculated

on sale or disposal.

Shares in a company, either through direct ownership oras shares in investment trusts that are themselves limited

companies, albeit as an 'umbrella holding' arrangement.

Units in a unit trust or Open Ended Investment Company(OEIC).

Debentures and bonds representing investments or loansto companies or the government.

Personal possessions such as art or antiques may be liableto Capital Gains Tax if they are worth more than 6,000 at

the date of disposal.

Business premises such as a shop, fixtures and fittings,goodwill or shares in a personal company.

Overseas assets including a holiday home abroad, sharesin a foreign company or land purchased for

development.

Exempt assets

Some assets are exempt from Capital Gains Tax, including:

An individuals principal private residence (the familyhome);

Private vehicles; Personal possessions worth up to 6,000 each at the date

of disposal as detailed above;


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Investment held under tax-free wrappers such as ISAs; Certain UK government investments such as: National

Savings Certificates, Premium Bonds and gilt-edged loan

stock issued by the Treasury;

Proceeds of gambling or chance such as the NationalLottery;

Foreign currency held for an individuals own or familysuse where the equivalent sterling value has risen due to a

change in the exchange rate.

Allowances

As with income tax, there is an annual allowance set each year.

The amounts are detailed in the tax tables forming part of this

text. Trustees also have an allowance to set against gains in

assets held within a trust, and this is currently 50% of the rate

applicable to individuals.

In very simple terms, ignore the matter of losses and other reliefs

that may be available. If the overall gain in any one tax year

exceeds the annual allowance, an individual will be liable to

CGT on the balance above the allowance. The current

percentage charge on the gain is a flat-rate 18%.

Inheritance Tax

Inheritance Tax (IHT) is usually due on an estate when an

individual dies but may also be levied on the transfer of assets

into a trust or as a gift before death to an individual. It was

widely believed that with ever-rising house prices, more and

more families would fall into the grip of Inheritance Tax but, with

the sharp declines in property values in recent years and the

ability to now use a spouses allowance, the numbers are

believed to have declined markedly. Even in 2006, which some

may have considered the peak of the problem before the

changes, the average house price was 185,000, which was


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well below the threshold at the time. It is estimated that only 7%

of estates paid any IHT during the tax year 20067.

The responsibility for payment of IHT falls on the executors of the

deceased persons estate or the trustees if applicable, where a

lifetime transfer has been made into a trust, or the done

(recipient) in the case of an outright lifetime gift.

Valuation

To identify if an estate is liable to IHT or may be liable as part of

the financial planning process, it is necessary to value both the

assets of the deceased, any proportion of jointly owned items,

and gifts they may have made during their lifetime or placed

into trust.

Exemptions and reliefs

Spouse or civil partner exemption. Inheritance tax is notlevied on anything left to a spouse or civil partner who

lives permanently in the UK and will not be applied to

gifts you make to them in your lifetime.

UK charity exemption. Any gifts made to a UK registeredcharity are exempt from Inheritance Tax.

Potentially exempt transfers. Subject to the donorsurviving seven years after making a lifetime gift to

someone, that gift will generally be exempt from

Inheritance Tax, no matter what the value.

Annual exemption. Individuals can give up to 3,000away each tax year, either as a single gift or as several

gifts adding up to that amount. It is also possible to utilise

any of the unused allowance from the previous tax year.

Small gift exemption. Small gifts of up to 250 can bemade to as many individuals as the donor wishes, tax-

free.

Wedding and civil partnership gifts. Gifts to someonegetting married or registering a civil partnership are


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exempt up to a certain amount depending upon the

relationship to the couple.

Business, Woodland, Heritage and Farm Relief. Ifindividuals own a business, farm, woodland or National

Heritage property, some relief from Inheritance Tax is

available; this is detailed in subsequent material.

Payment

Payment of IHT is normally due by the end of six months from the

end of the month in which the deceased died. Interest will be

chargeable if this is not paid. If the estate is tied up in property,

the tax may be payable in ten annual instalments.

Self-assessment

Self-assessment involves completing a tax return for submission

each year. This can be done either online or by using a paper

tax return. As well as the basic form, there are also

supplementary pages that may need completion covering such

areas as income from property, second employment or capital

gains. Over eight million people now complete self-assessment

for Income Tax purposes. Individuals will always have to

complete a self-assessment return if they are self-employed or in

control of their own business, such as a company director.

Forms are issued in April following the end of the tax year and

can be returned at any time, if self-assessment is completed

online the HMRC website generates the software necessary toautomatically calculate any tax payable.

Deadlines and penalties

Submission of a paper-based self-assessment return must reach

HMRC by midnight on 31 October following the end of the

relevant tax year. Filing online extends the deadline by 3 months

until 31 January. If HMRC receives the forms for filing late, there

will be an automatic 100 penalty.


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Payments

Individuals must pay any amount of outstanding tax by 31

January following the end of the relevant tax year.

Payments are usually made in three instalments. First, a payment

on account will need to be made on 31 January within the

relevant tax year. This is based on half of the previous tax years

liability. A further payment on account is made on 31 July

following the relevant tax year. This payment will generally be

for the same amount as the previous payment on account. A

final balancing payment will be made on 31 January following

the end of the relevant tax year based on the differencebetween the current years liability and the previous tax year

(assuming it is higher). You can see, therefore, that on the 31

January payment date, the taxpayer will need to make a

payment on account for the current tax year, and also a

balancing payment for any outstanding amounts from the

previous tax year.

If individuals fail to meet the appropriate payment dates, and

there is still an outstanding balance on 28 February, a 5%

surcharge will be added to the amount owed, and interest will

continue to accrue. An automatic penalty of 100 is levied if the

return is not submitted by the 31 January deadline date. A

further 100 fine is also charged If the return is outstanding 6

months later. These fixed penalties cannot exceed the amount

of tax due.

There are also variable penalties for failure to keep proper

records, errors in returns, deliberate omissions, etc.

PAYE system

Employees have their Income Tax calculated and collected by

their employer using the Pay as You Earn (PAYE) system. Pension


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providers operate in exactly the same way as employers in this

regard. Each year a tax code will be sent to the employer or

pension provider detailing the amount of tax free allowances

available for each individual. The employer is responsible for the

calculation and application of the coding to an individuals

income, and ultimately is responsible for remitting the tax

deducted to HMRC.

Generally speaking, in line with National Insurance Contribution

(NIC) payments, PAYE should be received by HMRC on the 19th

of each month if paying by cheque or the 22nd if electronic

transfer of funds is used. Late payment penalties and interest

may also apply from the tax year 201011.


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Revision exercise 1

The following questions are designed for use to help you

consolidate the information learned so far. Please write down

your answers and then review them against the suggested

answers that follow the questions.

Q1. State the normal payment date by which Inheritance Taxis due. Outline the consequences of not making payment

by the due date and explain how alternative

arrangements for payment may be provided. (4)

Q2.

List seven taxable state benefits. (7)

Q3. Outline the main personal allowances available toindividuals in connection with Income Tax. (5)

Q4. Explain the allowances applicable to Capital Gains Taxfor both individuals and trusts and the rate(s) of tax

payable. (3)

Q5. Detail the submission and payment deadlines with regardto self-assessment returns and any penalties or

surcharges that may accrue on such if these are made

late. (5)

Note: Typical points allocated in an exam are indicated in

brackets.


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Revision Answers

Q1 Answer

State the normal payment date by which Inheritance Tax is due.Outline the consequences of not making payment by the due

date and explain how alternative arrangements for payment

may be provided. (4)

IHT is normally due no later than 6 months from the end ofthe month in which the deceased died.

Interest will be chargeable if this payment is not met. The rate of interest is linked to the Bank of England base

rate.

If the executors are unable to realise sufficient assets, theliability may be met with 10 annual instalments.

Q2 Answer

List seven taxable state benefits. (7)

Bereavement Allowance Incapacity Benefit from week 29 Employment and Support Allowance Carers Allowance Jobseeker's Allowance Statutory Sick Pay, Maternity, Paternity and Adoption Pay Widowed Parent's Allowance.

Q3 Answer

Outline the main personal allowances available to individuals inconnection with Income Tax. (5)

Personal allowance (basic) Personal allowance (6574) Personal allowance (75+) Married/civil partners allowance


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Blind persons allowance.Q4 Answer

Explain the allowances applicable to Capital Gains Tax for bothindividuals and trusts and the rate(s) of tax payable. (3)

Each individual receives an annual allowance (10,100for 200910).

The allowance applicable to most trusts is 50% of theindividual allowance.

CGT is chargeable on the excess of the allowance at18%.

Q5 Answer

Detail the submission and payment deadlines with regard to

self-assessment returns and any penalties or surcharges that

may accrue on such if these are made late.(5)

Paper based self-assessment returns must reach HMRC bymidnight 31 October.

Filing online extends the deadline to 31 January. There is an automatic 100 penalty for late filing. Outstanding amounts must be paid by 31 January

following the end of the tax year.

If there is an outstanding balance on 28 February, a 5%additional surcharge will be applied.


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j01 personal tax study guide

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