2 Your manager has received a letter from Dana, a new client of your firm. Extracts from the letter and from an email from your manager are set out below.
Extract from the letter from Dana
Relief available in respect of a trading loss
I resigned from my job on 31 December 2009, having earned an annual salary of £40,000 for the previous three years. I spent the whole of 2010 planning my new business and began trading on 1 January 2011. The business was profitable initially but I made a loss in the year ended 30 September 2012.
The results of the business have been:
Period ended 30 September 2011 – a profit of £14,900.
Year ended 30 September 2012 – a loss of £30,000.
I own a number of rental properties that are let on long-term tenancies. On 1 February 2012, I sold one of these properties for £310,000. I paid £250,000 for this property on 1 December 2010.
My taxable property business profits in recent tax years have been:
2012/13 (estimated) 44,075
Please let me know how much tax I can save by relieving my trading loss for the year ended 30 September 2012.
Transfer of a rental property to a trust on 1 September 2012
On 1 September 2012, I transferred a rental property worth £270,000 to a trust for the benefit of my brother’s children. I assume that there will be no tax liabilities for me or the trustees in respect of this gift. I also transferred a rental property to a trust in December 2007 and I am sure that no tax was paid in respect of that gift. I have never made any other gifts apart from gifts of cash to members of my family; none of these gifts exceeded £2,000.
Email from your manager
Dana is unmarried and has no children. She is resident, ordinarily resident and domiciled in the UK.
I have just spoken to Dana and she has provided me with the following additional information.
– Dana received a bonus of £2,000 from her employer when she left her job in December 2009. The bonus was to thank her for all of the work she had done over the years.
– The results Dana has provided in respect of her unincorporated business have been adjusted for tax purposes but do not take account of expenditure she incurred during 2010. During that year, Dana spent £1,400 on petrol as she travelled around the UK visiting potential customers.
Dana had no income or capital gains in the tax years concerned other than those referred to in her letter and in the additional information set out above.
Please prepare the following for me for my next meeting with Dana.
(a) Relief available in respect of the trading loss
A reasoned explanation, with supporting calculations, of the most tax efficient manner in which Dana’s trading loss can be relieved, together with a calculation of the total tax relief obtained by following the most tax efficient strategy. I want you to consider all of the ways in which Dana could relieve the loss with the exception of carry forward for relief in the future. You should assume that gift relief will be claimed in respect of the transfer of the rental property to the trust on 1 September 2012 when carrying out this work.
Carry out the work required as requested in the email from your manager. The following marks are available.
(a) Relief available in respect of the trading loss.
In respect of part (a) of this question you should:
1 Ignore national insurance contributions.
2 Assume that the tax rates and allowances for the tax year 2011/12 apply to all years. (18 marks)
(b) Transfer of the rental property to the trust on 1 September 2012.
(i) Capital gains tax;
(ii) Inheritance tax.
(a) Relief available in respect of trading loss
A trading loss for tax purposes of £22,500 (W2) has arisen in the tax year 2012/13.
It can be relieved against Dana’s total general income of 2012/13, the year of the loss, and/or 2011/12.
Alternatively, because the loss has arisen in one of the first four tax years of trading, it can be relieved against Dana’s total general income of the three years prior to the year of the loss starting with the earliest year, i.e. 2009/10.
The income taxable at the higher rate in each of the tax years is set out below.
2009/10 2010/11 2011/12 2012/13
£ £ £ £
Employment income (W1) 32,000 – – –
Trading income (W2) – 4,500 6,000 –
Rental income 15,175 26,475 33,475 44,075
Less: personal allowance (7,475) (7,475) (7,475) (7,475)
—— —— —— ——
39,700 23,500 32,000 36,600
Less: basic rate band (35,000) (35,000) (35,000) (35,000)
–– –– –– –—
Income taxable at the higher rate 4,700 – (3,000) 1,600
–– –– –– —–
((£310,000 – £250,000) – £10,600) 49,400
Gains taxable at the higher rate 46,400
The claims against general income are all or nothing claims such that the trading loss will be offset in full in one of 2009/10 or 2011/12 or 2012/13, depending on which relief is claimed. Because an opening year’s claim would relieve the loss in full in 2009/10, it is not possible to relieve the loss in 2010/11.
The year with the most income taxable at the higher rate is 2009/10. Relieving the loss of £22,500 in that year would save income tax as follows:
£4,700 x 40% 1,880
(£22,500 – £4,700) x 20% 3,560
Relieving the loss in 2012/13 would clearly save less tax, as there is less income taxable at the higher rate in that year than there is in 2009/10.
There is no income taxable at the higher rate in 2011/12 but there are capital gains. Relieving the loss against the general income in the basic rate band would allow an equivalent amount of capital gains to be taxed in the basic rate band rather than the higher rate band.
Accordingly, relieving the loss in 2011/12 would save tax as follows:
£22,500 x 20% 4,500
Capital gains tax
(£22,500 x (28% – 18%)) 2,250
The most beneficial claim is to relieve the loss in 2011/12 in order to save tax of £6,750.
Notes in respect of the additional information provided by Dana:
– The bonus is in respect of work carried out by Dana for her employer. Accordingly, it is taxable in full in the year of receipt.
– The cost of travelling around the UK in 2010 would have been allowable had it been incurred after Dana began to trade. Accordingly, because it was incurred in the seven years prior to commencing to trade, it is treated as if it had been incurred on the first day of trading.
1. Employment income in 2009/10
Salary for nine months (£40,000 x 9/12) 30,000
2. Trading income
2010/11 (1 January 2011 to 5 April 2011)
£13,500 (W3) x 3/9 4,500
2011/12 (1 January 2011 to 31 December 2011)
£13,500 – £7,500 (£30,000 x 3/12) 6,000
2012/13 (Year ended 30 September 2012)
Loss (£30,000 – £7,500) (22,500)
The trading loss of £7,500 deducted in arriving at the taxable profit for the tax year 2011/12 is excluded from the loss available for relief in respect of the tax year 2012/13.
3. Trading profit for the nine months ended 30 September 2011
Original figure 14,900
Pre-trading expenditure (1,400)
(b) Transfer of the rental property to the trust on 1 September 2012
(i) Capital gains tax
Dana can claim gift relief in respect of the transfer of the property to the trustees because a lifetime transfer to any trust is a chargeable lifetime transfer subject to inheritance tax. The election must be signed by Dana and submitted by 5 April 2017 (i.e. four years after the end of the tax year in which the gift was made).
(ii) Inheritance tax
Information required in respect of the transfer to the trust in December 2007
– The value of the property at the time of the gift
The gift in December 2007 is within the seven-year period prior to the gift on 1 September 2012, such that it will affect the nil rate band available in respect of the latter gift.
Information required in respect of the gifts to family members
– Date, value, recipient and occasion of each gift
This information is required in order to determine whether the gifts to family members are exempt or not. This will affect the annual exemptions available in respect of each of the gifts to the trusts.
In addition to the annual exemption, the following lifetime gifts are exempt:
– Gifts of less than £250 in total to any individual in a tax year.
– Gifts of no more than £1,000, made on the occasion of a marriage or civil partnership.
– Regular gifts made out of income that do not affect Dana’s standard of living.