Chapter 24: Taxation

Question 1

Factors that need to be considered when attempting to maximise net of tax returns

Answer 1

• total rate of tax on an investment
• how the rate is split between different components of the investment return (income and capital gains)
• timing of tax payments
• whether tax is deducted at the ource or has to be paid subsequentially
• extent to which tax deducted at source can be reclaimed by the investor
• to what extent losses or gains can be aggregated between different investments or over different time periods for tax purposes

Question 2

These factors that need to be considered when attempting to maximise net of tax returns are affected by

Answer 2

• overall tax system
• particular tax rules for individual types of assets
• the investor’s own status
• the investor’s financial position (may affect average marginal rate of tax and any free-of-tax allowances)
• whether investments are held domestically or offshore
• tax-efficiency of vehicle used to hold assets

Question 3

“bed and breakfasting”

Answer 3

• Sale and repurchase of an asset in order to crystallise a capital gain
• If the gain from the sale and repurchase is less than the annual tax allowance then no tax liability will be incurred
• Thus subsequent capital gains will be taxed at the repurchase price and the eventual tax liability is reduced
• Also should consider the extra transaction costs though!
• Tax authorities may also insist on a minimum period between selling and repurchasing for the capital gain to be effective - thus, investors will have the risk that prices increase between this time

Question 4

Main forms of taxation

Answer 4

• Taxes on capital gains and income seperately
• Taxing total return
• Stamp duty - tax on purchase of an asset
• Witholding taxes paid on investments held overseas

Question 5

Three main systems of corporation tax

Answer 5

1. Classical
2. Split-rate
3. Imputation

Question 6

Classical system

Answer 6

• Company profits are taxed both in the hands of the company and the investor.
• The company pays tax on its profits, and then the investor is taxed on dividends received.

Question 7

Split-rate system

Answer 7

• As for the classical system except that different tax rates are levied on distributed and retained profits.
• Often used in conjunction with differential tax treatment of income and capital gains for individuals.

Question 8

Imputation system

Answer 8

• Company deducts some tax payable by investors on dividend distributions at source, and pays it directly to the government, allowing an offset against its total corporate tax bill.
• This tax is then imputed to the shareholders.
• No further tax is payable if the imputation rate is equal to the shareholder’s marginal tax rate, but tax-exempt investors may be able to reclaim the imputed tax, and those taxed at higher marginal rates will have to pay more tax on assessment.