Chapter 9 – Direct Investments (4 and 5 marks)

Question 1

Cash deposits
produce interest which, as we have seen, is classed as savings income

Fixed interest securities
produce interest, so once again is savings income
Property income

comes (generally) from rental income, which is non-savings income

Equities
produce dividends

(Remember all the types of income too as seen in chapter 1)

Question 1

This chapter is about direct investments. What are direct investments?

Answer 1

Where the customer invests directly into an asset class

Examples of income from direct investments include rental income, bank and building society interest, gilt and corporate bond income and share dividends.

Sources of investment income come from indirect investments such as pensions, OEICs & unit trusts and investment bond

Question 2

There are several ways that individuals can generate income from property. For example:

Letting whole properties
Letting rooms
Letting holiday properties
Income from woodlands

Question 3

Under the rent a roof scheme you can have a 7500 tax free allowance

What happens if more than 1 person receives the rent?

Answer 3

Where more than 1 person receives the rent the relief is £3750 per person

Question 4

Look at main points for 9.2. IMPORTANT

Question 5

LOOK AT EXAMPLE 9.1 FOR RENT A ROOM IN ACTION

Answer 5

REMEMBER, YOU CAN CLAIM TAX IN TWO WAYS IN RELATION TO RENT A ROOM

NORMAL BASIS (Where rent a room is not used) - allows u to deduct expense

Rent a room relief - first £7500 is tax free but cannot deduct expenses

Generally, the ‘normal basis’ method will only be better if the individual has sufficient other expenses to off-set.

Question 6

Those who let commercial property can benefit from ‘Plant and Machinery’ allowances.

What is this?

Answer 6

Those who let commercial property can also benefit from ‘Plant and Machinery’ allowances.

This sounds quite industrial (and does include machines and tools) but also covers more common office assets such as:

Office equipment
Office furniture
It should be noted that capital allowances are not available for furniture used in residential property. Instead, the landlord can claim Replacement Furniture Relief:

Question 7

What is Replacement Furniture Relief?

Answer 7

Available to landlords of residential property

The Replacement Furniture Relief allows landlords to claim a tax deduction for replacing furnishings in residential properties.

This relief covers capital expenses on items such as furniture, appliances, and kitchenware. Allows Landlords to deduct the replacement cost, minus any proceeds from selling the old item.

NOTE: However, the replacement of integral fixtures (e.g., toilets or sinks) is considered a repair and does not qualify for this relief.

Question 8

The replacement of integral fixtures (e.g., toilets or sinks) is considered a repair and does not qualify for Replacement Furniture Relief

True or false

Answer 8

True!

This relief covers capital expenses on items such as furniture, appliances, and kitchenware. Allows Landlords to deduct the replacement cost, minus any proceeds from selling the old item Does not cover integral fixtures

Question 9

What is the Property allowance?

Answer 9

Allows for the full relief on income tax if the turnover on a rental property is less than £1,000.

It need not be claimed, it can simply be ignored. Joint owners can both claim the £1,000 allowance.

Where property income exceeds £1,000 then the property owner has a choice. Either;

apply the £1,000 property allowance as a deduction of income or
deduct their actual expenses as normal.

Question 10

When a lease or sub-lease is granted for fewer than 50 years (a short lease), part of any sum received by a landlord is taxed as if it was property income. It is effectively HMRC’s way of saying; ‘You’ve received payment for a lease and that’s fine, but the shorter the lease, the more of the payment will be treated as income’.

This amount received for the lease is known as the premium, and the relevant percentage amount must be included in the property income accounts.

The amount taxable as income of the rental business is reduced by 2% of the premium for each complete year of the lease after the first

Answer 10

EXAMPLE:

The taxable income from a lease premium decreases as the length of the lease increases:

100% of the premium is taxable for leases less than 2 years.
98% is taxable for leases 2 years or more, but less than 3 years.
96% is taxable for leases 3 years or more, but less than 4 years.

This pattern continues, reducing the taxable percentage, until leases of 49 years or more but less than 50 years, where 4% of the premium is taxable.

Question 11

LOOK AT 9.2.3: Furnished holiday lets

Question 12

Look at NS&I Revision Sheet in 9.3

Question 13

To remember the tax free NS&I products remember PICK

Answer 13

PICK =
p- Premium Bonds
I - ISA’s
C - Certificates
K - Kids Bonds (ie children bonds)

you always should PICK the NS&I products that are tax free first

Question 14

Gilts

Generally, if gilts are held to redemption, there is no capital gain and therefore CGT is irrelevant. However, capital gains or losses can be made on trading gilts on the open market before the redemption date.

For directly-held fixed-interest securities, any gains are exempt from CGT. Because of this any capital losses made when trading fixed-interest securities can’t be offset against other gains.

Same applies to Local Authority Bonds (i.e. bonds that are issued by local government authorities).

Same applies to Corporate Bonds except Convertible Corporate Bond!!!!! IMPROTANT - CONVERTIBLE BONDS ARE not exempt from CGT.

Answer 14

Local Authority Bonds

The same CGT situation applies to Local Authority Bonds (i.e. bonds that are issued by local government authorities).

Question 15

Corporate bonds are exempt to CGT which is the same as GILTS and Local authority bonds. However there is one exception to corporate bonds. What is this?

Answer 15

Convertible Corporate Bond are subject to CGT

It is because they can be converted into shares (which are not exempt from CGT). Therefore remember that any sale of convertible corporate bonds before the exercise date IS NOT exempt from CGT.

Question 16

What are deep discount securities?

How are they taxed?

Answer 16

A type of fixed interest security that are issued at a reduced price compared to their final redemption amount by 15% or (if less) by 0.5% a year of the redemption amount calculated to the earliest possible redemption date.

When these are transferred (by sale, gift or otherwise), any capital gain is liable to INCOME TAX on the excess - not CGT

Deep discount bonds are therefore exempt from CGT to avoid a possible double-taxation.

Question 17

PIBS are high-yielding fixed interest investments issued by building societies. Similar to qualifying corporate bonds ( one similarity being that they exempt from CGT). they differ to corporate bonds in the following way however. How do they differ?

Answer 17

They pay a fixed rate of interest

The bonds have no redemption date

If a building society demutualises, any previously issued PIBS become perpetual subordinated bonds (PSBs).

The taxation of PSBs is identical to that of PIBS

Question 18

REMEMBER FIXED INTEREST SECUTIRIES IF HELD DIRECTLY ARE EXEMPT FROM CGT except convertible corporate bonds. (normal/qualifying corporate bonds are exempt tho) Deep discount securities are subject to income tax on any gain.

Question 19

Dividends represent the distribution of a company’s profits (or retained profits) to its shareholders. They can be a very important reason for investors to own shares – the anticipated return may not just be based on the underlying capital value of the company increasing.

Question 20

What is PID income in REITs?

Answer 20

PID (Property Income Distribution) is a term used in relation to REITs (Real Estate Investment Trusts). REITs are companies that own, operate, or finance income-generating real estate. The income they generate from property rental is distributed to shareholders as PID income.

Question 21

What are Stock / Scrip dividends?

9.4.1

Answer 21

A stock dividend (sometimes called a scrip dividend) is where a company offers the choice of receiving new shares instead of a cash dividend.

Question 22

How are Stock / Scrip dividends taxed?

Answer 22

A stock dividend (sometimes called a scrip dividend) is where a company offers the choice of receiving new shares instead of a cash dividend.

In this situation the investor is treated as having received income equal to the cash dividend. As such, they are liable to income tax on this amount at the same rates as if they had received the cash dividend.

If the market value differs substantially from the deemed cash dividend amount, the market value on the first day of dealing after issue would be substituted.

Therefore for CGT purposes, the acquisition cost of the shares is the:

Amount of the deemed cash dividend;
or
The market value of the new shares at issue if substantially different

Question 23

LOOK AT END OF FOR KEY POINTS OF ALL DIRECT INVESTMENT TAXATION. IMPORTANT TO DO

Question 24

Direct investments

Interest payments are now paid gross
Certain Cash investments are tax-free such as Cash ISAs and Premium Bonds

There are many ways that property can be used as an investment
Some would argue your main residence is an investment, but the exam focuses on second property purchases such as buy-to-lets and holiday homes plus income generated by renting out a room in your own house, rent a room relief
The final asset class is equities, owning a share of a company
Shares can in theory be bought in any private or public limited company, often ownership is of public limited companies
Private equity and venture capital investment is available and is discussed in the next chapter
Any interest earned is often liable to income tax and gains are taxed either to CGT or Income tax dependent on the type of investment

Question 25

Fixed interest securities are essentially loans to the government (Gilts), corporate bonds (loans to companies) and Permanent Interest Bearing Shares (PIBS) (previous loans to Building Societies)

Answer 25

Gilts, corporate bonds & PIBS pay interest to the holder which is normally distributed twice a year and is paid gross, but it is taxable

When purchased directly, these Fixed Interest Securities are all exempt from CGT on disposal (but, as a result, losses may not be offset)

Convertible corporate bonds are subject to CGT tho and Deep Discount Securities pay income tax on any gains

Question 26

Darren is a member of a building society that is planning to demutualise. He has been informed that he is due to receive a cash bonus on demutualisation and is interested in the tax consequences. Which of the following most accurately describes the tax situation?

The cash bonus is in effect a payment made for Darren giving up his membership rights and is a disposal for CGT purposes

The cash bonus is in effect additional savings income provided by the building society to Darren and is taxable at his marginal rate

The cash bonus is in effect dividend income provided by the building society to Darren and is taxable at his marginal rate

The cash bonus is not subject to either income tax or CGT

Answer 26

The cash bonus is in effect a payment made for Darren giving up his membership rights and is a disposal for CGT purposes

Although this is true, in most cases the chargeable gain will be less than the annual exempt amount, so whether CGT is actually due often depends on the other disposals the individual has made during that tax year

Question 27

Which of these explanations of the tax position of certain National Savings and Investments product are CORRECT?

(Choose more than 1 answer)

The interest earned within Investment Accounts is paid without any deduction of tax but is taxable as savings income in full

National Savings Certificates are only free of all taxes if they are held for the full term

Income Bonds pay interest net of 20%

The interest paid from qualifying Children’s Bonds is not taxable

Guaranteed Income Bonds income is paid gross

Answer 27

A, D & E

Remember the PICK acronym for tax-free NS&I products? This includes Certificates and Children’s Bonds, whether they are held for the full term or not. Now, all other NS&I products not covered in the ‘PICK’ mnemonic pay their income gross, but it is taxable.

p- Premium Bonds
I - ISA’s
C - Certificates
K - Kids Bonds (ie children bonds)

Question 28

Chris, a client of yours and a higher rate taxpayer, has inherited a number of gilt-edged securities from his sister. The total holding amounts to approximately £10,000. He should be aware that:

(Choose more than 1 answer)

The interest is normally paid twice yearly on each gilt

He can use his Savings Allowance of £1,000 to help reduce his income tax liability on the Gilt coupons

The interest is taxed as savings income on a current year basis

He can sell any of the gilts prior to redemption and any losses he makes are allowable for CGT purposes

Due to Chris’s overall holding, any accrued interest in sales proceeds will be liable to income tax

Answer 28

A, C & E

The interest from gilts is paid gross.

A higher rate taxpayer can set their Savings Allowance against Gilt income, but only to a maximum of £500.

Gilts are exempt from CGT which means that, although gains are CGT-free, losses cannot be offset. THIS WOULD BE UNFAIR OTHERWISE

The ‘Accrued Interest Scheme’ is fairly obscure, but means the income liability on accrued interest is not charged if the overall nominal holding is £5,000 or less. In this case, that does not apply to Chris, who holds approximately £10,000 of gilts.

Question 29

Samuel, a basic rate-taxpayer, is interested in investing in Permanent Interest-Bearing Shares as the return appears to be high. He should be aware that (Choose more than 1 answer)

he can use his Dividend Allowance against income produced by the PIBs

they pay a variable rate of return

they are only issued by building societies

they pay interest twice a year

they are subject to CGT on disposal

Answer 29

C & D

Although they are called ‘shares’, PIBS are a form of fixed interest security and therefore pay fixed interest, not dividends. As a result, the Dividend Allowance is not applicable (but the Savings Allowance would be). They are exempt from CGT on disposal.

Question 30

Andy is a non-taxpayer, Brian is a basic rate taxpayer and Colin is an additional rate taxpayer. If they each receive a £3,000 dividend cheque in respect of their shareholdings in the same UK company: (Choose more than 1 answer)

only Andy will receive the cheque gross

only Brian will have a 20% income tax liability

only Colin will have a 39.35% income tax liability

Andy and Brian will have the same tax liability on the dividend

The Dividend Allowance for each person is £500

Answer 30

C & D

All dividend payments are paid gross. Brian, as a BRT, has a liability of 7.5% on the dividend (at least for the £2,500 above the Dividend Allowance). Colin, as an ART, has a liability of 39.35% (again, at least for the £2,500 above the Dividend Allowance). Andy has no liability as a non-taxpayer, but can still benefit from the £500 Dividend Allowance – they all can!

EVERYONE HAS A £500 DIVIDEND ALLOWANCE

Question 31

tRUE OR FALSE: EVERYONE HAS A £500 DIVIDEND ALLOWANCE

Answer 31

True

Doesnt matter if u are an addition rate tax payer, basic rate or anything else

Question 32

Jackie has recently purchased a property on the south coast and is planning to let it out. Assuming she meets the conditions for the property to qualify as a furnished holiday let, which of these following advantages is INCORRECT?

The activity will be treated as a trade for the purposes of loss relief

Jackie will be able to pay pension contributions on the basis of the income she receives from the property

CGT entrepreneur’s relief is available when Jackie disposes of the property

The first £7,500 of rental income is not charged to income tax

Answer 32

The first £7,500 of rental income is not charged to income tax

The £7,500 of tax-free rental income applies to ‘rent-a-room’ relief, not furnished holiday lets

Question 33

LOOK AT THE FURNISHED HOLIDAY LET SECTION