Direct investments Flashcards
Cash deposits
Bank account or building society account interest and interest on products from NS&I is paid gross.
• Individuals who receive interest, whether it arises in the UK or offshore, must include the interest in their tax returns and pay any tax due on it at the appropriate tax rate.
Gilts
Gilts usually pay a fixed rate of interest and are thus often classed as fixed interest stocks. The interest is usually paid twice yearly, paid gross and taxed as savings income.
Any investor can elect for 20% income tax to be deducted at source from the interest. This will be the full liability for a basic-rate taxpayer. A higher-rate taxpayer has to pay a further 20% of the gross interest, while an additional-rate taxpayer has to pay a further 25%. Obviously, deduction of 20% income tax would not be helpful if the interest falls within the investor’s personal allowance or starting rate band or is covered by the personal savings allowance.
Gilts may be held until maturity or alternatively, sold at a profit or loss on the stock exchange.
For individuals, gilts are exempt from CGT, so profits are tax free and losses are not allowable.
Any accrued interest in the sale proceeds is liable to income tax if the individual’s total nominal holding of gilts exceeds £5,000 on any day in the tax year.
Corporate bonds
Corporate bonds, such as debentures and other loan stocks, are effectively loans to a company that bear interest for a fixed term, at the end of which the capital is repaid.
• Depending upon the bond’s precise terms, the company may be able to repay the loan earlier if it wishes.
• The interest paid by the company is paid gross and is taxable as savings income (see Interest on page 1/8).
If the bond meets the conditions for qualifying corporate bonds, any gain is exempt from CGT.
Deeply discounted securities
Certain securities issued at a discount are subject to special rules to prevent avoidance of income tax. A relevant discounted security is any security the issue price of which is less than the amount payable on redemption by 15% of that amount or, if less, by 0.5% a year of that amount to the earliest possible redemption date. Shares and most gilts are excluded from these rules.
When individuals transfer (by sale, gift or otherwise) or redeem a relevant discounted security, and the amount payable on the transfer or redemption exceeds the amount paid for its acquisition, they are liable to income tax on the amount of the excess less any costs of acquisition and transfer or redemption of the security. If a loss arises, it may be relieved against income in the tax year.
To avoid the same gain being liable to income tax and CGT, relevant discounted securities are deemed to be qualifying corporate bonds and therefore exempt from CGT.
Local authority bonds
Local authority bonds are effectively loans to local government authorities at a fixed rate of interest, usually for a relatively short fixed term.
• Interest is taxed in the same way as interest from corporate bonds (see Corporate bonds on page 9/4), being paid gross and taxable as savings income.
• If a bond is bought at issue and held to maturity, the capital will be repaid.
• They are qualifying corporate bonds and therefore, exempt from CGT.
• Some bonds can be bought and sold on the stock exchange, but no chargeable gains or losses arise on disposal by individuals because they are exempt from CGT.
Shares
As investments, shares offer the prospect of income in the form of dividends, and capital growth if they are sold (on or off the stock exchange) at a profit.
• The cost of buying and selling shares includes the stockbroker’s commission and the difference between buying prices and selling prices listed by market makers.
• Share prices can rise or fall according to the fortunes of the company and general market conditions.
• Gains are potentially subject to CGT: losses are usually allowable against other gains for the same year or following years in the usual way.
Stock dividends
Sometimes companies offer shareholders the choice of receiving new shares instead of a cash dividend. This is called a stock dividend.
• The shareholder is treated as having received income equal to the cash dividend.
• The market value of the new shares on the stock exchange on the first day of dealing after issue would be substituted as the deemed dividend if that market value differs substantially from the amount of the cash dividend.
• The stock dividend is taxed in the same way as a cash dividend.
• When new shares are acquired in this way, the acquisition cost for CGT purposes is the amount of the cash dividend or, if substantially different, the market value of the new shares at issue.
Overseas dividends
Investors who receive dividends from shares in companies outside the UK are liable to income tax at the same rates as on dividends from UK companies.
• Most overseas dividends are paid after the deduction of withholding tax.
• Double taxation agreements usually set out a rate of withholding tax that a country can charge a UK resident.
• The withholding tax can be set against the investor’s UK tax liability on the income. If the withholding tax exceeds the UK tax due on the income, the excess is not repaid.
Investment trusts
An investment trust is not a trust as such. It is a limited company that invests its shareholders’ money in other stocks and shares.
Investment trusts provide a way for a private investor to obtain a professionally managed investment in a wide spread of companies. The investor buys shares in the investment trust and becomes a part-owner of it.
• The investor usually receives income from the shares in the form of dividends, which are generated by the dividends from the shares held by the investment trust. Investment trust shares are listed on the stock exchange and the investor can sell them at any time and realise a profit or loss.
• The taxation of income and gains arising from investment trust investments is the same as for shares. However, interest distributions are treated as savings income.
Real estate investment trusts (REITs) are a special vehicle for investing in property.
In principle, property income is subject to income tax, although there are special rules that reflect its business-like nature:
capital gains on property are subject to CGT;
• the purchase of a property may be subject to stamp duty land tax (SDLT) in England and Northern Ireland, land and buildings transaction tax (LBTT) in Scotland or land transaction tax (LTT) in Wales; and
• property purchases and rent may also be subject to value added tax (VAT).
General position
The income received from letting property is liable to income tax in a similar way to a business.
• Tax is charged on the property (rental) income an individual or partnership makes from letting property.
• Profits are calculated using ordinary accounting principles, applying most of the tax rules for computing trading profits.
The default basis of calculating property income is the cash basis (where rental income does not exceed £150,000), but the landlord can opt for the accruals basis.
• Income from all UK properties is pooled together, regardless of whether the property is subject to a lease or whether the property is furnished or unfurnished. Overseas property income is taxed separately from UK property income.
• Although property letting is taxed as a business, the income is investment income, not earned income, and does not count as ‘relevant UK income’ for making pension contributions, except when it arises from furnished holiday lettings. Certain other reliefs available to businesses, such as setting-off losses against other income, are not available for property letting.
• An annual £1,000 property allowance means that property income is exempt if it is less than £1,000 (before deducting expenses). If property income is more than £1,000, then the £1,000 allowance can be claimed against income – instead of deducting actual expenses.
Deductible expenses
Any expenses incurred in earning rental income can be deducted, these are referred to as deductible expenses. These include repairs and maintenance and letting agency fees.
C2A Repairs and maintenance
Expenditure on repairs is allowed, but not the cost of alterations and improvements, or the cost of bringing a newly bought building into a fit state for letting. Expenditure reimbursed by insurance is not deductible.
C2B Interest
Tax relief for finance costs in respect of residential property (such as mortgage interest, interest on loans to buy furnishings and fees incurred when taking out, or repaying, mortgages or loans) is restricted to a basic rate tax deduction. For example, if finance costs are £4,000, then the basic rate tax deduction will be £4,000 at 20% = £800. The restriction does not apply where finance costs relate to a furnished holiday letting or to non-residential property, such as an office or warehouse.
Other expenses for Property
Legal fees for renewals of short leases (less than 50 years’ duration), debt collection and eviction of bad tenants.
• Professional charges for rent collection and property management.
• Premiums for insuring the property.
• Water rates, ground rents and council tax where paid by the landlord.
• Gas and electricity where paid by the landlord.
• Business mileage calculated either at HMRC’s fixed rate per mile (see Mileage allowances on page 1/21) or based on the actual cost.
• The cost of any services provided and paid for by the landlord, e.g. cleaning and gardening.
Plant and machinery allowances
Many common business assets, such as office equipment, furniture and machines or tools, are considered to be plant and machinery for capital allowance purposes, and expenditure on them could qualify for plant and machinery allowances.
These allowances are available for capital expenditure on equipment installed in let property or used in maintaining it.
• Equipment that forms part of a building is not eligible for allowances.
• There are no capital allowances for furniture used in residential property; instead, replacement furniture relief may be claimed.
• Furniture and other equipment used in a commercial property is eligible for capital allowances. A certain amount of expenditure each year on the purchase of plant and machinery for use in the property letting business (such as office equipment used by the owner to manage the business) qualifies for the 100% annual investment allowance (AIA) in the year of purchase. Up to 31 December 2020, the AIA limit is £1m, with a limit of £200,000 from 1 January 2021 onwards. Therefore, the overall maximum for 2020/21, where accounts are prepared on a tax year basis (see Basis of assessment on page 9/ 9), is £800,000 ((£1,000,000 × 9/12) + (£200,000 × 3/12)).
Any expenditure in excess of the AIA limit qualifies for a writing-down allowance at the rate of 18%. The remainder is carried forward on a reducing balance basis.
Basis of assessment -property
Income from letting property is taxable in the tax year in which it arises.
• Accounts have to be prepared for the actual tax year, although HMRC usually accepts accounts to 31 March instead of 5 April.
• Tax is payable under the self-assessment rules together with tax on the individual’s income from all sources.
