The Calculations for the Capital Gains Tax - Case Study Example

AF3S11 TAX ASSIGNMENT 2007/08 Case of Mr. Darling Letter addressed to Mr. Darling: Dear Mr. Darling Re: Impact of Budget for the year 2008 on your taxable income We have made a review of the information provided by you on the status of your income and capital gains. For your review we have appended your income tax computation for the years 2007-08 and 2008-09. We write to advise you the following with respect to the applicability of the income tax and capital gains. Capital Gains Tax Major changes have been brought in the budget for the year 2008 in respect of the capital gains tax. The indexation allowance and taper relief which have so far been allowed are withdrawn and in that place a flat rate of 18 percent of the chargeable gains has been introduced. The calculations for the capital gains tax are shown in the appendix. From the calculations it may be observed that it is advisable to sell off the business building before 05th April 2008 as you can avail the indexation allowance and taper relief which are no more available. It may be noted that the indexation and taper relief are the allowanced granted by the government to provide for the increase in the asset value due to inflation (Chris Horne). In case you decide to sell of the property after 05th April 2008 you many have to pay higher CGT of 18,000. However in the case of the personal paintings since they have been acquired only in the year 2005 they do not stand eligible for any allowances and the capital gains will simply be the difference between the sale proceeds and the cost. Hence in this case it is advisable to sell the paintings after 05th April 2008 as the CGT on the chargeable gains can be paid at lower tax rate of 18 percent. As a measure of tax planning the sale proceeds of the business building may be invested in an Enterprise Initiative Scheme (EIS) which are qualifying investments for CGT refund. National Insurance Contributions Income from employment is subjected to income tax as well as Class 1 National Insurance Contributions NIC). Payment of the Tax and NIC are normally undertaken by the employer through the PAYE system. However the employee who has other incomes subjected to tax and whose tax is not fully paid by the employer may complete a tax return and pay the NIC. Contributions to NIC are being made by both the employer and employee. The employee has to make contributions to NIC at 11percent or 9.4 percent between the primary threshold limit and the upper earnings limit. A charge of 1 percent is payable for earnings above the upper earnings limit. No NIC is payable by the employee or employer on the earnings up to the primary threshold limit. Depending on whether the employee is within the State Second Pension (S2P) or whether he has contracted out using a final salary (FS) or money purchase scheme (MP) the rates of NIC payable on earnings are determined. Particulars Contracted in Within S2P Contracted Out Other than S2P Primary Threshold to Upper Earning Limit 11.0% 9.4% Above Upper Earning Limit 1.0% 1.0% As per the calculations shown in the appended income statement assuming that you have contracted out of the state pension scheme, you may have to contribute 9.4 percent of 23,760 i.e. 2233.44 towards the National Insurance Contribution. Additional Tax Burden on Cigarettes and Wines We understand that you and your wife are both heavy smokers and drinkers. Beware that the budget for the year 2008 has put additional tax burden on the cigarettes, wine, and beer to the extent of 0.14p on a bottle of wine, 0.4p on a pint of beer and 0.11p on a pack of cigarettes and to this extent the cost of these items would go up. We do hope you will revise your consumption of these items in view of increased burden on your income. Other Tax Credits The budget for the year 2008 has made the following changes in other Tax Credits for which you are entitled. Tax Credits 2007-08 2008-09 Child Tax Credit - Family Element 1,845 2,085 Working Tax Credit - Basic 1,730 1,800 Married Couple Allowance 2,440 2,540 We have provided you with the computation of your income along with the tax workings for the year 2007-08 and 2008-09 assuming that you will effect the transactions of sale of the business building in the year 2007-08 and the paintings in the year 2008-09 to make the maximum tax savings in the CGT and Income tax. We shall be pleased to provide you any additional details you may need in this connection. 2. Case of Mrs. Brown Letter Addressed to Mrs. Brown Dear Mrs. Brown Re: Impact of Budget for the year 2008 on your Taxable Income We have carefully reviewed the details of the income provided by you and the impact of the budget proposals of the government for the year 2008 on your taxable income. The relevant tax calculations and the probable tax payable by you on the income for the year 2007-08, 2008-09, and 2009-10 are appended with this letter. The following are some of the important implications that are cast by the budget for 2008 on your taxable income which we request you to take note of: Property, Plant and Machinery - Additions In the case of small businesses a first year allowance to the extent of 50 percent of the new additions to the plant and machinery was being provided for the year 2007-08 which can be claimed as deduction from your business earnings. However the budget proposals for the year 2008-09 have allowed an annual investment allowance of up to 50,000. This provision allows the first 50,000 of the qualifying expenditure to be written off in the year of purchase. This provision will bring some good for your business, as there are additions to the plant and machinery of your business every year. Similarly if there is a balance of 1000 or less in a general pool of assets you can write of this amount completely for tax purposes. This has the advantage of not claiming a number of smaller writing down allowances in future years (Pentlands). Car Allowance In the case of motor cars up to and for the year 2007-08 a writing down allowance of 25 percent on the reducing balance subject to a maximum of 3000 was allowed as deduction. From the year 2008-09 this rate has been revised to 20 percent on reducing balance subject to a maximum of 3000. However it may be noted that an allowance of up to 100 percent is allowed in respect of motor cars emitting not more than 110 g/km CO2. This allowance is available till 31st March 2013. As you are a keen supporter of environmental protection probably you may change the car to get this extra allowance in the income tax and at the same time contribute your share to the environmental protection (Rothman Pantall & co). Value Added Tax (VAT) Normally the standard rate of VAT for the business with turnover exceeding the threshold limit of 64,000 is 17.5 percent or 747 of the consideration received for making a supply. However there is a concession available in respect of small business with turnover less than 150,000 to opt for a single flat rate scheme. Under this scheme the rate of VAT varies with the type of business. Here VAT is applied on all receipts and no costs are taken into account for charging V VAT. The single rate is lower than 747 for compensating the business for the input tax lost by them. Since the turnover of your business is 100,000 we would advise you to opt for this single flat rate scheme which may advantageous from the tax angle (Hartley Fowler). Some advises for Tax Planning We give below few suggestions for reducing the tax burden by a careful planning. Since the tax slab for your husband is low, you can plan some investment income such as bank interest or dividend is payable to him so that there will be considerable tax saving. If the family business concern is a sole proprietorship or a partnership you may consider admitting your husband as a partner and allocate a share of the profits from the partnership firm to him since he is in lower tax bracket. This is suggested in case if he is already not a partner in the business. Alternatively you can employ your husband as your personal assistant and there is no prohibition in making a salary payment to him so that the tax incidence on the business income will be reduced to that extent. It is only necessary that there should be a proper work contract and all the salary payment should go through the PAYE system. Since for most of the self employed people the office extends later in the evening at home. If you have a provision in your house you can allocate one room exclusively for office purposes and claim tax relief. If the house is a six roomed one and one room is allocated for business purposes you can claim one sixth of the heat, light and insurance and repair costs as tax deduction from business income. However you should note that if you decide to sell the house at a later stage, proportionate capital gains tax will be calculated for the value of the room used as a business asset (Ronnie Ludwig, 2006). We have addressed only a few salient features of the changes brought about by the Budget for the year 2008. If you are in need of any other details on other points please do get in touch with us. We shall be pleased to provide you with the necessary information. Appendix Mr. Darling Calculation of Capital Gains Tax Building - Business Asset Particulars Sale Prior to 05th April 2008 Sale After 05th April 2008 Sale Proceeds 135,000 1,35,000 Less: Cost 35,000 35,000 Net Value 100,000 100,000 Less: Indexation 2,940 0 97,060 100,000 Less: Taper Relief 75% 70.795 0 Chargeable gains 24,265 100,000 CGT @ 40%/18% 9.706 18,000 Indexation: 162.6 - 150 150 = 0.084 = 35,000 x 0.084 = 2,940 Taper Relief = 75% of 97,060 Note: If the annual exemption of 9,200 is considered then the CGT would be as below: Chargeable gains 24,265 100,000 Less: Annual Exemption 9,200 9,200 Net Gain 15,065 90,800 CGT @ 40%/18% 6,026 16,344 Paintings - Non-business Asset Particulars Sale Prior to 05th April 2008 Sale After 05th April 2008 Sale Proceeds 45,000 45,000 Less: Cost 30,000 30,000 Net Value 15,000 15,000 Less: Indexation 0 0 15.000 15,000 Less: Taper Relief 0 0 Chargeable gains 15,000 15,000 CGT @ 40%/18% 6,000 2,700 No Indexation allowance or Taper Relief is available as the paintings were acquired after 6th April 1998 Note: If the annual exemption of 9,200 is considered then the CGT would be as below: Chargeable gains 15,000 15,000 Less: Annual Exemption 9,200 9,200 Net Gain 5,800 5,800 CGT @ 40%/18% 2,320 1,044 Income Tax Computation of Mr. Darling Amount in Year 2007-08 2008-09 Particulars Earnings Gains Total Earnings Gains Total Income 35,000 35,000 Business Asset 24,265 Paintings 15.000 Total Income 59,265 50,000 Personal Allowance 5,225 5,435 Annual Exemption(*assumed) 9,200 9.500* Total Exemptions 14,425 14,935 Net Income 29,775 15,065 44,840 29,565 5,500 35,065 Child Tax Credit - Family Element 1,845 2,085 Working Tax Credit - Basic 1,730 1,800 Married Couple Allowance 2,440 2,540 Total Allowances 6.015 6.425 Net Taxable Income 23,760 15,065 38,825 23,140 5,500 28,640 Starting Tax 2230 at 10% 223 Basic rate 21530 at 22% 4736.6 CGT 15,065 at 40% 6026 Starting Tax 23,140 at 20% 4,628 CGT 5,500 at 18% 990 Total Tax 10,985.6 5,618 Calculation of Income Tax for Mrs. Brown For the year 2007-08 Amount in Particulars Earnings Dividends Savings Income Total Income 20,000 8,000 10,000 38,000 Personal Allowance 5,225 Net Income 14,775 8,000 10,000 32,775 Married Couple Allowance 2,440 Net Income 12,335 8,000 10,000 30,335 Car Allowance 3,000 First year allowance 10000 at 50% 10,000 Adjustment of Loss (665) Net Taxable Income/(loss) (665) 8,000 9,335 17,335 Basic rate 8,000 at 10% 800 800 Starting rate 2,230 at 10% 223 223 Basic rate 7,105 at 20% 1,421 1,421 Total Tax Payable 800 1,644 2,444 For the Year 2008-09 Amount in Particulars Earnings Dividends Savings Income Total Income 22,000 10,000 12,000 44,000 Personal Allowance 5,435 Net Income 16,565 10,000 12,000 38,565 Married Couple Allowance 2,540 Net Taxable Income 14.025 10,000 12,000 36,025 Car Allowance 3,000 Fist year investment allowance 20,000 Adjustment of Loss (8,975) Net Taxable Income/(Loss) (8,975) 10,000 3,025 13,025 Basic rate 10,000 at 10% 1000 1,000 Starting rate 2,230 at 10% 223 223 Basic rate 795 at 20% 159 159 Total Tax Payable 1,000 382 1,382 For the Year 2009-10 Amount in Particulars Earnings Dividends Savings Income Total Income 25,000 15,000 15,000 55,000 Personal Allowance (assumed) 5,645 Net Income 19,355 15,000 15,000 49,355 Married Couple Allowance " 2,750 Net Taxable Income 16,605 15,000 15,000 46,605 Car Allowance 3,000 First year Investment Allowance 25,000 Adjustment of Loss (11,395) Net Taxable Income/(Loss) (11,395) 15,000 3,605 18,605 Basic rate 15,000 at 10% 1500 1,500 Starting rate 2,230 at 10% 223 223 Basic rate 1,375 at 20% 275 275 Total Tax Payable 1,500 498 1,998 References Chris Horne 'Capital Gains Tax (CGT) - UK Landlord' Ezine Article Hartley Fowler 'Tax Facts 2007' < Pentlands 'Budget Update' Ronnie Ludwig (2006) 'Commandment Three: Minimise what you pay in Income Tax' Rothman Pantall & co 'Main Capital Allowances' Read More