The Concept of Taxation - Essay Example

I. Introduction Taxation is the life blood of a nation. The concept of taxation is derived from the theory of protection and support, where the citizens give tax to the government in exchange for protection. Every country has its own taxation system which is evolving according the needs of time. The evolution of the taxation systems in the United Kingdom is evident in the many revisions of our tax law. There revisions in the law is mostly reflected in the changing tax rates, allowances and systems of collection. The three problems in this essay tackles different scenarios involving different transactions. Problem 1 The first problem involving Ms. Vaughan involves a sale of a house giving rise to the payment of Capital Gains Tax (CGT). CGT can only arise on the disposal of an asset, which is this case is the house. However, not all sales of properties are subject to CGT. The most common exemption and is relevant to the case we have is the sale of a person’s principal private residence. In identifying whether such sale is taxable or not, let us look into the facts involved in the case. Ms. Vaughan bought the property in Brechin in 2 January 1982. She resided in that house until May 1984 before moving to Germany. From then on until 31 August 1990, she did not reside in that house not even on holidays. She lived in that house again from June 1995 until May 2002 where at the same time, she lent a large portion of the house to a tenant. In June 2002, she moved to Liverpool and was never able to live in the house in Brechin again. The question now is whether or not the house in Brechin is the primary resident of Ms. Vaughn. A primary consideration in determining whether such house is the primary residence of a person is the time spent is that place and the intent to go back to such place and establish residence. Under our tax code, residence simply means the place where one lives. Determining ones residency is dependent on ones length of stay, number and frequency of trips to the place (i.e. habitual stay) and the intention to stay in that particular place. Judging by the amount of time Ms. Vaughan spent in the property in Brechin and the fact that she lent the house to a tenant while she occupied only a portion thereof belies the fact that she wants to establish the place as her primary residence. Thus, such sale of property do not fall under the exemption provided for under the law. In computing the capital gains tax due, the rules is to compute the person’s tax rate first and use the highest tax rate as basis for capital gains tax. To illustrate: Salary from employment 32,000.00 Less; personal allowance (4,895.00) __________ Taxable income 27, 105.00 Note that the since the bank interest of 3,000 had already been subjected to tax at source, it may not be included in the computation of tax base anymore as it will constitute double taxation. To compute the taxable gains , certain costs are allowable in computing chargeable gains: The acquisition cost or market value on 31 March 1982 (if the asset was acquired before that date). Costs of acquiring and disposing of the asset. Indexation allowance (where applicable) Therefore, figures are as follows: Sales of property 255,000.00 Less: Original Cost of Property (42,000.00) ___________ 213,000.00 Less indexation allowance (42,000 x 1.047) (43,974.00) 169,026.00 The indexation allowance in capital gains tax is computed based on the indexation rate of March 1982. It must be noted that implementation for individuals of indexation allowance is only between March 1982 to 1 April 1988, thus we compute based on March 1982 using the prevailing purchase price amount of 42,000.00. There was no mention in the problem of the amount of acquisition of the property nor any amount for repairs and enhancements thus, it would be proper not to consider these deductions. On the remaining amount, Ms. Vaughan can apply the taper relief since she held the property for seven whole years beyond 1 April 1998. For non-business assets held for seven whole years after 1998 and held at 17 March 1998, a bonus of one year is added to the 7 whole years, therefore we get the percentage of gain chargeable of 70%. The 30% is your allowance. Thus, the computation shall be as follows: 169,026.00 x 70% = 118,318.20 In combining the two illustrations we get the following financial presentation: Particulars Earnings Gains Total Income/gains 32,000.00 118,318.20 158,769.50 Personal allowance (4,895.00) (4,895.00) Annual exemption (8,500.00) (8,500.00) Taxable 27,105.00 109,818.20 136,923.20 Tax due computation Starting rate: 2090 at 10% 209.00 209.00 Basic rate on earnings: 25,015.00 at 22% 5,503.30 5,503.30 Capital gains tax (31,310 – 25,015 =5,295.00) 5,295.00 x 20% (109,818.20 – 5,295.00) = 104,523.20 x 40% 1,059.00 41,809.28 42,868.28 Note that the capital gains tax is treated as the top slice of the income and the highest tax rate should apply thereto. Thus, computation was as follows: the first 8,500 of the net gains realised during the tax year is free of CGT. The excess is taxed as if it were the top slice income, at the rates that apply to savings income, namely 10% on the first 2,090.00, 20% on the next 30,310 and 40% on the balance. The indexation allowance was computed using the derivation table for indexation allowance. Problem 2 The second problem is about the sale of a company property. The proceeds of the sales was used to purchase another property which will be used the company in connection with its business. The question here is on the possibility of availing the rollover relief provisions of the tax law. The answer is yes. This is quite an unusual feature of the Capital Gains Tax which distinguishes it from Income Tax. In CGT, you do not need to pay Capital Gains Tax if you have spent the proceeds from the sale on buying other assets. This is not magnanimity by the Inland Revenue. It simply reflects economic reality. It would stifle economic activity if companies were charged tax every time they sought to replace their old assets with new ones of equal value. Roll-over relief applies where the new assets which are acquired are "non-wasting", e.g. freehold land and buildings, long leases. In this case the new assets can be acquired at any time between one year before and three years after the old asset was sold. The tax liability arising from the sale of the old asset is "rolled into" the new asset and is thereby deferred for so long as the new asset is retained. If the new asset is subsequently sold, the rolled-up CGT becomes payable, but it can be deferred again by buying another non-wasting asset. In our case, McGraths sold the old property for the amount of 350,000.00 and used the proceeds thereof to buy the Rickfield Property for 335,000.00 and a recording van in the amount of 75,000.00. The Rickfield property could not be put to use until 30 June 2006 but the van was used immediately. As per the provisions of the law, these two transactions fall under the rollover category. Although the Rickfield property will not used immediately considering the existing lease which the current lessee refused to give-up, such instance do not make the property a wasting asset. The lease is not long term but is only for a few months. The mobile recording van on the other hand is an essential component of the business and should be treated as such. Therefore, in computing for capital gains tax, the following would illustrate why the company should be made to pay CGT. Sales of property 350,000.00 Less the cost of replacement assets Rickfield property (335,000.00) Mobile recording van (75,000.00) __________ Total (60,000.00) The equation ended in a negative figure which means the company infused more capital to augment the budget for purchasing the replacement assets. Problem 3 The 3rd problem is about sales of shares of stocks. Muriel Hope have the following shares; Date Number of Shares Cost/(Proceeds) 2 December 1979 4,000 2,600 22 May 1997 500 625 31 January 1998 1500 3,000 25 July 1999 Rights issues 6,000 18,000 10 March 2000 1000 4,250 15 December 2005 sold (9,500) (42,000) To avail of the taper relief under the tax law, we follow the last in first out principles of accounting where shares and securities disposed are identified with acquisitions in the following order; Same day acquisitions Acquisitions within the following 30 days Previous acquisition after 5 April 1998 Any share in the pool at 5 April 1998 Any shares held 5 April 1982 Any shares acquired before 6 April 1965. Using the last in first out method of accounting, the shares shall be deemed disposed according the following table; Date Number of Shares Cost/(Proceeds) No. of Shares Sold 2 December 1979 4,000 2,600 (500) 22 May 1997 500 625 (500) 31 January 1998 1500 3,000 (1,500) 25 July 1999 Rights issues 6,000 18,000 (6,000) 10 March 2000 1000 4,250 (1000) 15 December 2005 sold (9,500) (42,000) Pooling of shares of stocks is allowed if such shares are acquired (or treated as acquired) after 5 April 1982 but before 6 April 1988 as long as they are of the same class, in the same company and acquired at the same capacity. Thus, the stocks acquired 22 May 1997 and 31 January 1988 attracts indexation thus we compute as follows: No. Cost Indexed/total Cost 2 December 1979 4,000 2,600.00 2,600.00 Pool starts 22 May 1997 500 625.00 625.00 Index to 31 January 1988 159.5 – 156.9 ___________ x 625 10.35 156.9 Add: 31 January 1988 1,500 3,000.00 3,000.00 25 July 1999 6,000 18,000.00 18,000.00 10 March 2000 1,000 4,250.00 4,250.00 __________________________________________________________________ Total Cost 13,000 28,475.00 28,485.35 Sales of Stocks (9,500) (42,000.00) (20,816.20) Left 3500 13,525.00 7,669.10 Gain is then calculated as follows: Post 1998 July 1999 and March 2000 shares 6,000 + 1,000 = 7,000 Thus: 7,000/9,500 x 42,000 = 30,947.35 Less cost (18,000 + 4250) (22,250.00) Gain 8,697.35 Taper relief for non-business held for 6 years full years qualifies for 25% relief thus: (8,697.35 x 20% = 1739.47) 8,697.35 – 1,739.47 = 6,957.90 net gain after taper relief Tape relief for stocks held before 1998 (2,500/9500 x 42,000) 11,052.60 Less Cost (6,225.00) Less indexation allowance (10.35) Gain 4,817.25 Taper relief for non-business held for 6 full years plus bonus of 1 year is 25% thus: 4,817.25 x 25%= 1,204.30 4,817.25 - 1,204.30 = 3,612.90 gain after taper relief Therefore, to compute capital gains tax, we come up with following financial presentation: Particulars Earnings Gains Income/gains 29,750.00 4,817.20 Personal allowance (4,895.00) Annual exemption (8,500.00) Taxable 24,855.00 (3,682.80) Tax due computation Starting rate: 2090 at 10% 209.00 Basic rate on earnings: 22,765.00 at 22% 5,008.30 We have a negative balance after deducting all the allowable deductions therefore, there is no taxable capital gains tax. Bibliography 1. Deliotte Haskins & Sells. (2005) How to Minimize Capital Gains Tax. 2. Mark McLaughlin and Michael Dawson. (September 2002) Case Study Rollover Relief 3. Lecture notes and cases Read More