The Best Offer due to Its Potential of Maximizing the Untaxed Capital Gain - Case Study Example

Finance and Accounting Case Study Question Liam and Irene should consider the offer that will maximize the capital gain they will accumulate from the sale. Consequently, the couple should consider the effect of the moving date and the price under each offer in determining the actual amount that will be accumulated. This is because the capital gain accrued from sale of residential houses does not attract capital gain taxation due to the private residence relief residence (CIOT, 2014). The moving date will determine the cost the couple will incur in servicing the current mortgage rate and insurance cover during the months the new owner will take over the house. This is because the couple will be required to cater for the monthly mortgage fee and insurance premium before the new owners move in. Consequently, the computations below illustrated the actual amount each of the three offers will generate. First offer; Price = £193,200 Moving date = 1 month192720 Mortgage and insurance cover cost = £425 + £55 = £480 Net amount realized = £193,200 - £480 = £192,720 Second offer; Price = £194,000 Moving date = 2 months Mortgage and insurance cover cost = £480 * 2 = £960 Net amount realized = £194,000 - £960 = £193,040 Third offer; Price = £195,000 Moving date = 3 months Mortgage and insurance cover cost = £480 * 3 = £1,440 Net amount realized = £195,000 - £1,440 = £193,560 Consequently, the analysis above reveals that the third offer is most preferable for the couple due to its potential of maximizing the untaxed capital gain they will accumulate (King & Carey, 2014). This implies that the couple should consider selling their house to the third buyer at the price of £195,000. Even though the offer will cost the couple a higher maintenance, the strategy will allow a realization of a higher net value of the house. Question 2 The optimal decision that Liam should undertake on the 1,000 shares he inherited from his father is to sell them at the current lower price. This is because the strategy will allow Liam to avoid capital gain tax from the sale of the inherited shares. Shares that are inherited use the market value price at the day they were inherited if they were inherited after 31st of March 1932 by the new owner (Mclaughlin, 2013). Owing to the recent sharp decline of the distillery shares, the current price is likely to be lower than the market value of the shares at the day of their inheritance. Thus, Liam will avoid paying lump sum tax amount by selling the shares at their current prices instead of keeping them in future that might attract tax (Spencer, 2013). In addition, selling the shares currently will allow Liam to claim for capital loss in his tax return. This is because the net amount that will be realized from the sale of the shares will be lower than the market value of the shares at the day of their inheritance. Even though the price of the shares will be lower than the market value under consideration, the value of the shares has the potential of been higher to that of the original price his father acquired the shares. Consequently, the excess amount over the real market value of the shares at their original date will be exempted from taxation if Liam sells the shares today (Finney, 2009). This is an optimal strategy since it will save Liam a significant tax remittance. Question 3 Liam mother is wrong in her feelings that it would have been better for her to undertake permanent health insurance (PHI) compared to critical illness cover. This is due to the different benefits that the two insurance covers protect individuals’ income. Permanent health insurance cover is designed to cover the person insured with an alternate income if they are incapable of working due to illness or accident (Moyer, 2012). The alternate income is provided to the person until their retirement, death or they return to work. In contrast, the critical illness cover gives a lump sum amount of money to the person insured when he/she is diagnosed for a critical illness (Schanz, 2011). Thus, Liam mother is in a better position under the critical illness cover due to her current age. The retirement age in UK is 65 years that means she has only five years to the retirement since she is currently at 60 years. If she had taken the permanent health insurance cover, she will retain her income for the next five years or earlier if she is able to work (Chand, 2009). The cumulative amount she will earn from the insurance cover will be relatively low due the short time to retirement. However, the critical illness cover allows her to receive lump sum money at her current age since it is paid once the insured is diagnosed (King & Carey, 2014). In addition, she is able to accrue more income if she returns to work if she recovers from the minor stroke (King & Carey, 2014). Question 4 Liam and Irene in their consideration to undertake a life insurance cover, university and school fees plan, have considered some aspects of their current life should not be disclosed when applying for the cover. This has the potential of denying the couple the benefit of the insurance cover in the event one of them dies. The failure to disclose everything that might trigger a fatal incidence in future will make the insurance company to decline issuing the pay out. Even though the undisclosed information will not be used deliberately by the couple to receive the benefits, the insurance provider will decline to pay the benefits due to no-disclosure provision. Full disclosure is an essential requirement when applying for insurance policy under the principle of good faith (Finney, 2009). The horse-riding hobby of Irene has the potential of causing loss of life if a serious accident occurs. Similarly, Liam yacht has the potential of experiencing a fatal incidence if the weather changes negatively when they riding in the coast causing death. This implies the two activities are crucial in determining the insurance premium (King & Carey, 2014). Consequently, the decision not to disclose these aspects to the insurance provider amounts to non-disclosure case that will cause the beneficiaries to lose the pay out in future if an accident arises. Thus, the couple should consider making full disclosure to the insurance provider when undertaking the life assurance cover (Finney, 2009). This will ensure the children are able to access full education cover if one of the parents dies in future. Question 5 The current pension position of the couple is determined by the current salary of Liam after working for the last ten years and the pension scheme under application. This is because the accrual rate application of the pension scheme implies that the pension scheme is final salary type (King & Carey, 2014). Thus, the current pension will be calculated as shown in the formula below. Current pension position = 10/80 * £62,000= £7,750; where 10 is the number of years he has worked and 1/80 is the accrual rate of the scheme. Consequently, the amount the couple should expect from the pension if Liam retires at the NRA of the company that is 60 years is as reflected in the computation below. Years to retirement = 60 – 38 = 22 years Total years of work = 22 + 10 = 32 years Retirement pension fund = (32/80 * £62,000) * 3 = £74,400 In order for the couple to take advantage of the tax free lump sum amount of money upon at the end of the pension scheme, Liam should wait until he reaches the age of 60 before he can withdraw the fund (Moyer, 2012). The retirement age of Liam’s company is 60 years. This is because withdrawal before the retirement age attracts taxation that will lower the amount one receives. In addition, withdrawing before the retirement age has the potential of attracting stiff penalty by the government (HMRC.com, 2014). Thus, the couple should withdraw the pension fund once Liam reaches the age of 60 years for the investment to be tax-efficient. Question 6 Liam tax liability; Salary £62,000 Pension contribution (£4960) Craigellachie Foundation aid (£800) Non-saving taxable income £56,240 Saving income £20 Dividend £440 Shares capital gain (£6.25 – £3.2) * 2,000 = £6,100 Taxable income £62,800 Tax rate 32.5% Tax liability £20,410 Irene tax liability; Salary £26,000 Interest income £380 Taxable income £26,380 Tax rate 20% Tax liability £5,276 This implies that Liam is supposed to pay £20,410 tax return while Irene is supposed to remit tax return equivalent to £5,276. Question 7 In determining the option that Irene should undertake between selling the stock investment currently or withholding the stock investment until the redemption date, the capital gain that will be accrued will be used. The optimal capital gain should be considered since it will not increase tax liability because treasury stock gains are exempted from taxation (King & Carey, 2014). Current price = £114 * 100 = £11,400 Annual return = £8,000 * 4.75% = £380 Gross interest yield = £380/£11,400 * 100 = 3.33% Net redemption yield; Current yield = 4.75% Gain/loss = £114 - £100 = £14 £14 * 100 = £1400 Years to maturity = 2022 – 2014 = 8 years £1400/ 8 years = £175 £175/£8,000 * 100 = 2.2% Redemption gain = 4.75% + 2.2% = 6.95% Owing to the information above, Irene should keep the shares until the redemption day in 2022 since it will earn higher gain compared to selling at the current price. The factor that should be considered is the capital gain that will be accrued from the two options of selling the treasury stock at the current price or retaining them until their redemption date. The higher potential rate of return from the two alternatives should be considered by the investor. Thus, Irene should hold the stock investment until it redemption date. This is because withholding the shares until their day will attract a net earnings return of 6.95% while selling the shares currently will attract a lower return of 3.33% (King & Carey, 2014). Thus, selling the shares currently will deny the investor the optimal return of 6.95% compared to 3.33%. Question 8 Endowment mortgage is a type of a mortgage loan that uses interest only payment arrangement that allows the capital to be repaid using single or additional low cost endowment policies (Khan & Jain, 2010). Thus, the mortgage holder is expected to pay interests only to cover the capital borrowed in owning the house. In contrast, the capital and interest mortgage is a type of a mortgage loan that obliges the holder to be paying monthly payments catering capital borrowed and cost of the capital (interest cost) over an agreed period (Chand, 2009). This implies that holder repays the capital through interest and capital amounts through monthly installments to own the house fully. Consequently, the two types of mortgage loan differ on the repayment schedule the holder is supposed to observe. Question 9 Investing through savings scheme is better than buying shares under the OEIC arrangement since it has a lower risk. This is because the shares have the potential of losing their market price to that of the original price of the shares that will cause the investor to incur capital loss (Khan & Jain, 2010). If an investor buys shares through a lump sum amount worth £10,000 at the beginning of the OEIC investment, she is exposed to the risk of losing the capital investment gains if the market value of the shares decline significantly in future (Finney, 2009). In contrast, investing through monthly savings scheme promises the investor a fixed return rate of their capital investment. This implies the investor faces a lower investment when undertaking savings scheme OEIC (King & Carey, 2014). For example investing monthly amounts under individual saving account, the rate of return of the savings will retain their fixed rate of return (Finney, 2009). Consequently, Liam should invest through monthly savings scheme over the share purchase due to the lower risk of the investment. Question 10 P = (C + E)* R* (1 + R)N/ (1+ R)N – 1(Moyer, 2012) Where P is per installment payment, C is the initial amount of the loan, E is the loan fees, R is the interest rate and N is the number of loan terms. C = £14,500 R = 7.9% per annum N = 5 years P = £14,500 * 7.9% * (1 + 7.9%)5/ (1 + 7.9%)5 – 1 P = £1,675.34/ 0.46 P = £3,642 Total payment = £3,642 * 5 = £18,210 Interest = £18,210 - £14,500 = £3,710 APR = £3,710/ £14,500 * 100 = 25.59% Question 11 Determining the amount accumulated under a compounding interest savings account, the formula below is applied. A = P * (1 * R/N)NT (Moyer, 2012) Where A is the amount accumulated, P is the principal amount, R is the interest rate, N is the times the interest is compounded annually and T is the number of years. Thus, amounts of the two accounts are as computed below. (a) P = £7,000 R = 2.95% N = 5 years A = £7,000 * (1 + 2.95%/5)5 = £7,000 Interest amount = £7,000 - £7,000 = £0 This implies that the savings did not accrue interest income to the investor for the five years. (b) A = £13,826.81 R = 2.35% N = 4 years P = £13,826.81/ (1 + 2.35%/4)4 P = £13,826.81/ 1.024 P = £13,502.74 This implies the account has accrued interest income for the investor for the 40urs years it was held. Reference Chand, S. N. (2009). Public finance. New Delhi: Altantic Publishers & Distributors. CIOT. (2014). Capital gains tax private residence relief final period exemption consultation draft clauses: Response by the Chartered Institute of Taxation. Retrieved 2014, from http://www.tax.org.uk/Resources/CIOT/Documents/2014/01/140124%20PPR%20Final%20Period%20Exemption%20-%20CIOT%20comments.pdf Finney, M. (2009). Wealth management planning: The UK tax principles. West Sussex, England: John Wiley & Sons. HMRC.com. (2014). Pension schemes and tax - the basics. Retrieved March 2014, from http://www.hmrc.gov.uk/pensionschemes/tax-basics.htm Khan, M. Y., & Jain, P. K. (2010). Financial management. New Delhi: McGraw-Hill. King, J., & Carey, M. (2014). Personal finance: A practical approach. Oxford: Oxford University Press. Mclaughlin, M. (2013). Tax planning 2013/14. S.l: Bloomsbury Professional. Moyer, R. C. (2012). Contemporary financial management. Mason, OH: South-Western, Cengage Learning. Schanz, D. (2011). Business taxation and financial decisions. Heidelberg: Springer. Spencer, P. (2013). Property tax planning. Haywards Heath: Bloomsbury Professional. Read More