10.3 National Insurance, Capital Gains, Inheritance Tax

Question 1

Who pays National Insurance?

Answer 1

National Insurance contributions are paid by employees and the self-employed once aged 16 and over, as long as their earnings are more than a certain level.

Question 2

What are contributory benefits?

Answer 2

State benefits that are linked to your National Insurance contributions are known as ‘contributory benefits’. Notably, these benefits include the State Pension.

Question 3

What determines the amount and type of National Insurance Contributions (NICs) paid?

Answer 3

The amount and type of National Insurance Contributions (NICs) paid depends on whether an individual is employed or self-employed and the amount they earn.

Question 4

Who pays Class 1 (primary) NICs?

Answer 4

An employed person

Question 5

What are the details of Class 1 (primary) NICs?

Answer 5

Contributions are deducted from your wages by your employer if you earn above a primary contribution threshold.

The employer also contributes:
• Class 1A NICS on tax benefits, such as a company car
• Class 1B NICs on PAYE income

Question 6

Who pays Class 2 and Class 4 National Insurance contributions?

Answer 6

A self-employed person

Question 7

What are the details of Class 2 NICs?

Answer 7

Class 2 NICs are paid at a flat rate if profits are above a small profits threshold.

Question 8

What are the details of Class 4 NICs?

Answer 8

Class 4 NICs are paid as a percentage of annual taxable profits above a certain level.

Question 9

Which married women can get a reduced rate of national insurance and what are the implications of this?

Answer 9

Married women (who applied prior to May 1977) are entitled to a reduced rate of National Insurance. Whilst this results in smaller deductions from wages, it also means that they are less likely to meet the minimum level of contributions needed for a full state pension.

Question 10

How does one qualify for the full state pension?

Answer 10

They must have made 35 years’ worth of NICs

Question 11

What are 3 reasons why some people may not have accumulated enough contributions to qualify for the state pension?

Answer 11

1. Are not working and are not claiming state benefits
2. Have not paid enough NICs in a year to count for the State Pension or other long-term state benefits
3. Live abroad and want to maintain their state benefits entitlement. To rectify this, regular Class 3 voluntary contributions can be made.

Question 12

On what gains is a UK resident liable for capital gains tax?

Answer 12

Gains arising anywhere in the world

Question 13

How does the CGT allowance affect each UK resident?

Answer 13

Each UK resident has a CGT allowance each tax year (£12,300 2021/22)

Question 14

What are the rules around capital losses and CGT?

Answer 14

Capital losses made in any one year can be carried forward indefinitely to set against future gains.

Question 15

Which investment product is exempt from CGT?

Answer 15

There is no capital gains tax on qualifying bonds (bonds that pay coupons) – this includes:

1. Gilts
2. Corporate bonds
3. Local authority bonds
4. Permanent interest-bearing shares (PIBS)

Question 16

What is the annual capital gains tax exemption?

Answer 16

The annual capital gains tax exemption is £12,300 in 2021/22.

Every UK resident receives a new CGT exemption each tax year, but it is a ‘use it or lose it’ exemption; unused exemptions cannot be carried forward.

Question 17

Which capital gains are chargeable to capital gains tax?

Answer 17

Only capital gains above the exemption each tax year are chargeable to capital gains tax. Remember that this exemption is applied after any gain has been reduced by other costs and losses.

Question 18

Outline the process of assessing the amount liable to CGT.

Answer 18

1. Proceeds on disposal
2. Reduced by:
   – Cost of asset
   – Any other allowable costs
   – The CGT annual exemption
   – Losses carried forward
3. Capital Gains Tax is now chargeable

Question 19

Explain the Gains Tax exemption for married couples and civil partners.

Answer 19

A transfer between spouses or civil partners is not a chargeable transfer in respect of CGT. This means that if spouses or civil partners transfer assets to each other, it will not incur CGT.

This leads to a common tax planning strategy. If an asset was held in the name of one spouse, they can add on the other spouse to the register of owners before they sell the asset. This will allow the investors to benefit from two lots of CGT exemptions i.e. 2 x £12,300 = £24,600.

Unmarried couples are not able to do this.

Question 20

What are the capital gains tax rates?

Answer 20

If a capital gain still exists after all of the costs and allowances described, it is taxed at 10% for a basic rate taxpayer. For higher and additional rate taxpayers the rate is 20%.

Question 21

How much CGT is paid on residential property?

Answer 21

Residential property that is not the owner’s main residence is charged at 18% for basic rate taxpayers and 28% for higher and additional rate taxpayers.

Question 22

How does the disposal of certain business assets affect CGT?

Answer 22

The disposal of certain business assets will attract entrepreneurs’ relief, which results in an effective rate of CGT at 10%.

Question 23

Mary bought an asset for £12,000 in 2008. She sells it in 2021/22 for £28,000. She also sold another asset at a loss of £900 in the same year. As a higher rate taxpayer, what is her CGT liability?

Answer 23

• The capital gain on Mary’s asset is the proceeds of the asset minus the cost of the asset.
• This is £28000 minus £12000 which gives us a capital gain of £16000.
• Mary made a capital loss of £900 in the same year. If we take away the loss of £900 and the annual exemption of £12300. Mary’s taxable gain is £2800.
• As Mary is a higher rate taxpayer she will pay CGT at 20%. 20% of £2800 is £560, hence Mary pays £560 in capital gains.

Question 24

List the 10 assets which are exempt from capital gains tax.

Answer 24

1. Primary residence
2. Gambling and National Lottery wins
3. Shares in enterprise investment fund schemes and seed enterprise investment schemes sold for the first time, having been held for the relevant holding period
4. Individual savings accounts (ISAs)
5. Gilts and qualifying bonds
6. National savings certificates and premium bonds
7. Private motor cars
8. Life assurance policies
9. Currency bought for holidays
10. Gifts to charities

Question 25

List 5 assets which are liable to capital gains tax.

Answer 25

1. Company shares and non-qualifying bonds
2. Second property or any subsequent properties
3. Other chattels above £6,000 – antiques, art, stamps, etc.
4. Currency bought and sold for gain
5. Units in CIS

Question 26

What are the rules surrounding capital gains tax and ISA wrappers?

Answer 26

Shares, collective investment schemes and property can all be ISA wrapped – meaning that they would not be subject to Capital Gains Tax.

This is a considerable benefit over time as each year more and more of a client’s portfolio can be ISA wrapped.

Question 27

What kind of tax is inheritance tax?

Answer 27

Inheritance tax (IHT) is mostly a tax on assets on death, but there is one situation where IHT is payable in life.

Question 28

How are persons considered chargeable for inheritance tax?

Answer 28

Chargeable persons are considered not on residence but on domicile.

Question 29

What are the IHT rules for a UK domiciled individual?

Answer 29

The estate of a UK domiciled individual is liable for IHT on their worldwide assets.

Question 30

What are the IHT rules for a non-UK domiciled individual?

Answer 30

The estate of a non-UK domiciled individual is liable for IHT on their UK assets only.

Question 31

What are the three types of transfer relating to inheritance tax?

Answer 31

1. Potentially exempt transfers
2. Chargeable lifetime transfers
3. Exempt transfers

Question 32

What is a potentially exempt transfer?

Answer 32

When a gift is made to another person (in excess of the nil-rate band) it is termed a ‘potentially exempt transfer’. It is potentially exempt because the donor (the giver) needs to survive seven years from the date of the gift, or the gift may be liable to inheritance tax.

Question 33

What is the seven-year clock and what is the purpose of it?

Answer 33

The seven-year rule or the ‘seven-year clock’ is designed to stop individuals trying to give away assets just before their death to avoid paying inheritance tax (death-bed transfers). The result of the seven-year clock is that to legally avoid paying inheritance tax, assets should be given away earlier in life when the donor is in good health.

Question 34

What does HMRC do when an individual dies?

Answer 34

On death, Her Majesty’s Revenue and Customs (HMRC) looks back seven years to find any potentially exempt transfers.

Question 35

What happens if the individual dies within the seven-year clock?

Answer 35

Any transfers made within the last seven years are liable to be added back to the estate. However, the rate that will be applied reduces from the third year after the gift was made.

Question 36

What is a chargeable lifetime transfer?

Answer 36

Whilst transfer into trusts for the disabled are ‘potentially exempt’, a transfer into a discretionary trust is deemed a chargeable lifetime transfer, if it exceeds the nil-rate band. This will incur an immediate IHT charge of 20%, and could be liable for more if the donor dies within seven years of the gift.

Question 37

List 4 transfers which are totally exempt from inheritance tax.

Answer 37

1. Individual’s annual IHT exemption – £3,000 per tax year. If not used this can be carried forward one year only (giving a potential maximum of £6,000 in any single year)
2. Gifts in contemplation of marriage – gifts to a bride and groom are exempt to these limits: parents, £5,000
3. Transfers between spouses and civil partners – fully exempt unless one spouse is a non-UK domicile then a £55,000 limit applies
4. Transfers to charities – exempt from IHT. If more than 10% of the estate is left to charity, the IHT rate is reduced by 10% to 36% for the remainder of the estate

Question 38

How is inheritance tax calculated?

Answer 38

Inheritance tax is payable on the value of a deceased person’s estate. All of a deceased person’s assets are valued and any liabilities are deducted.

Each UK domiciled individual receives the nil-rate band of inheritance tax, currently £325,000.

This means that the first £325,000 of an estate is charged at 0%. Inheritance tax is then charged on the excess above the nil-rate band at 40%.

Question 39

Explain the main residence nil-rate band.

Answer 39

• This measure introduces an additional nil-rate band when a main residence is passed on death to a direct descendant.
• For the current tax year, 2021/22, it is £175,000.
• There is a tapered withdrawal of the main residence nil-rate band for estates worth more than £2 million.

Question 40

Explain the process of gifting the nil-rate band.

Answer 40

The unused percentage of the nil-rate band, including main residence nil-rate band, can be transferred between spouses and civil partners. This works as follows:
• If one spouse of a married couple died in July 2018 and did not use their nil-rate band at all, then 100% of it is available to the other spouse on their death whenever that occurs. If, for example, the other spouse dies five years later when the nil-rate band has risen, say, to £350,000, the other spouse will receive both their own and their deceased spouse’s nil-rate band of £350,000 + £350,000 = £700,000.
• If part of the nil-rate band has been used, then the unused percentage can be transferred in the same way.
• This change has effectively given married couples and civil partners up to £650,000 (2 x the nil-rate band) of IHT protection without the need to pay solicitors to set up a tax efficient will.

Non-married couples do not benefit from this change.

Question 41

Explain gifts with reservation.

Answer 41

Under the rules of inheritance tax it is not possible to ‘pretend to give away’ assets and keep using them as your own.

This is called a ‘gift with reservation of benefit’. It occurs when the giver (the donor) of an asset is still able to use the asset for free i.e. still gaining a benefit from the asset.

A good example is an expensive family home. Imagine an expensive family home that is valued well over the combined nil-rate and main residence nil-rate bands at £1,850,000 and likely to incur quite a sizeable IHT bill. What if the parents decided to gift this home to their children and yet still live in the home themselves?

If the parents continue to live in the house as before then the tax authorities would class the gift as a gift with reservation – because they are still obtaining the benefit from their home by living in it. This means that the seven-year clock will not start ticking, and on death of the parents the house will be included within their assets for IHT purposes.

On the other hand, if the parents were to pay a market rent, this would not be a gift with reservation and the seven year clock would start ticking.