Sample STEP Diploma level taxation question and solution Question Your senior partner has asked you to take over the case load of your work colleague who has been on sick leave for some months and is unlikely to return to work before the end of the year. The first case that you review concerns the estate of Basil Sparrow, a long established client whose financial affairs had been managed by the firm for many years. Basil died on 5 February 2008 and your firm has been instructed by the executors to deal with the estate and tax matters arising. The file contains scribbled notes and jottings, a lengthy file note of a meeting held with the executors at the office in early May 2008 and sundry paperwork from which you establish the following: Basil was aged 66 at the time of death and is survived by his wife, Grete (age 34) and two sons from his first marriage, Bill (age 44) and Ben (40). The two sons are executors of the estate and the file contains several letters from them requesting an update on progress made to date – it would seem that the younger son has experienced some financial difficulties and is anxious to receive his inheritance. No distributions of income or assets have been made to date nor has the IHT return been prepared or any IHT paid on account. The terms of Basil’s will were simple and provided for: Legacies: 
£20,000 to an animal Charity. 
£15,000 to each of three grandchildren (free of tax). 
£250,000 plus chattels to surviving spouse. Residue: 
To sons Bill and Ben in equal shares. The file provides you with a useful thumbnail sketch of Basil’s background: Until age 55, Basil had lived a modest life – he was careful with his wealth (some might even say parsimonious), was heavily committed to his work as a publisher with its long work Sample STEP Diploma level Taxation Question and Solution October 2012 hours and spent little time with his family. However, a health scare at age 55 prompted him to reconsider his lifestyle – he took early retirement, married his second wife whom he met on a visit to Norway and took more of an interest in his immediate family both emotionally and financially. His estate on death comprised: Stocks and shares: 
£50,000 5% stock value at 90p – 94p ex div interest due 30 April and 31 October. 
10,000 Meerkat Plc quoted at 121p – 129p with bargains recorded at 121p and 123p. 
2,000 Monty Plc quoted at 252p – 260p with a single bargain at 252p. 
1,000 Green Ideas Ltd (an AIM listed company) valued at £8,000.The shares were purchased 18 months ago. 
Other quoted shares valued at £15,000. Property: 
Freehold house valued for probate at £650,000 (100% value) owned jointly with surviving spouse. “Windsurf”, a holiday home located on the south Devon coast, owned as tenants in common with the surviving spouse. The house, valued for probate at £200,000 (100%) had been purchased by Basil on his retirement and he had gifted a 50% share to his wife Grete on their second wedding anniversary some 8 years ago. Cash deposits: 
West Moorlands Bank – cash ISA £40,500. 
MidSomer Norton Bank ‐ £250,000 plus interest accrued to date of death of £1,400 (net). Sample STEP Diploma level Taxation Question and Solution October 2012 
St Mary Mead Build. Soc. ‐ £220,000 12 month fixed term bond plus interest accrued to date of death of £8,000 (gross). Other: 
Vintage car valued by local 4x4 dealer and fellow enthusiast at £24,000. 
Personal jewellery with a second hand value of £2,500. 
Household Furniture valued at £6,000. 
Book collection of first edition Agatha Christie mysteries – Basil had intended to sell these at auction some six months prior to his death but had changed his mind at the last minute. The auction guide was £100,000. Trust: 
Basil was the life tenant of a Trust established by his father on his death in 1990 – on Basil’s death the trust was valued at £176,000 (comprising quoted shares and cash). The Trust terminated on Basil’s death and the trust fund passed to Bill and Ben in equal shares. Liabilities: 
Funeral expenses of £4,700 (inclusive of hotel reception to celebrate Basil’s life – cost £1,500). 
Credit cards totalling £1,350 mainly comprising gifts for Grete to the value of £1,000. 
Sundry expenses totalling £250. During his lifetime, Basil made the following gifts: 1 Jan 01 Nephew £5,000
30 Jun 01 Son Bill £10,000
30 Jun 03 Son Ben £25,000
31 Oct 03 Trust in favour of sister 31 May 06 Addition to Trust £300,000
£50,000
Sample STEP Diploma level Taxation Question and Solution October 2012 30 Nov 07 Granddaughter £25,000
There is a footnote to the hand‐prepared schedule of lifetime gifts, which states: 
Basil’s sister had been widowed in early 2001 and Basil had created the Trust for the sister in order to provide her with a source of financial security. The Trust provided income to the sister for life with remainder to the children on her death. 
The gift to the granddaughter was on the occasion of the registration of her civil partnership. The working papers make reference to a separate file which, when examined, contains copies of submitted self‐assessment tax returns for all years up to and including the year ended 5 April 2007. The 2008 return for the period to the date of death has been prepared and indicates a net tax liability of £1,800 ‐ no payments were required to be made on account. The return also indicates a net loss of £2,000 realised on the sale of investments. You establish the following position post death: Period to 5 April 2008 Income ‐ Interest (net) £1,884 Interest (gross) 3,000 Dividends (net) 1,574 Capital transactions – None Expenses chargeable to income – None Year ended 5 April 2009 Income ‐ Interest (net) 5,800 Interest (Gross) 3,080 Sample STEP Diploma level Taxation Question and Solution October 2012 Dividends (net) 3,510 Capital transactions ‐ 30 June 08 – Take‐over of Meerkat Plc by Animal Software Plc for £2.75 cash per share. 30 Sept 08 – Take‐over of Monty Plc by Oscar Plc for a mix of £2.00 cash per share plus 2,000 shares in Oscar Plc with a value of £3.00 per share. 03 Mar 09 – Take‐over of Green Ideas Ltd by Footprint UK Plc for 0.65p cash per share. Note: Ignore effect of SP 2/04 Expenses chargeable to income ‐ £1,150 You are required to: 
Prepare a statement showing the amount of IHT payable on death, indicating upon whom the burden falls, in what proportion and the due date for payment. Make brief notes of appropriate observations made as part of your case review and outline any appropriate required actions and any additional required information. 
Outline the process and purpose of the CG34 procedures. (24 marks) (4 marks) 
Calculate the tax liability of Bill and Ben as executors in relation to the estate income and chargeable disposals arising in the estate administration period for the two years ended 5 April 2009. (8 marks) 
Explain the process to be applied in arriving at the total of residuary estate income available for distribution, indicate when and how that income will be treated in the hands of the residuary beneficiary. Your answer should be supported by illustration. (4 marks) Total 40 marks Sample STEP Diploma level Taxation Question and Solution October 2012 Suggested Solution Part (A) – Estate on Death Stocks Property Spousal exemption Balance Cash deposits Balance Chattels Spousal exemption Balance Interest (net) Ex‐dividend interest (net) Liabilities Charity legacy Spousal legacy Net chargeable Estate Trust fund Total IHT thereon at 40% £
425,000
(325,000)
40,500
250,000
220,000
132,500
(132,500)
7,800
586
4,700
1,350
250
1,800
20,000
250,000
£ 85,740 100,000 510,500 Nil 8,336 704,576 (8,100) 696,476 (270,000) 426,476 176,000 602,476 240,990 Sample STEP Diploma level Taxation Question and Solution October 2012 IHT burden allocable: Estate Trust 240,990 x 426476/602,476 240,990 x 176,000/602,476 170,590 70,400 Estate Distribution Total 696,476 Legacies – Charity 20,000
Spousal 250,000
Grandchildren 45,000
IHT 170,590
(485,590) Residue to sons Bill and 210,886 Ben Notes and Observations: Home ‐ passes to spouse by survivorship. Windsurf ‐ follows Will direction. Chattels ‐ include vintage car, furniture, jewellery, books. As gift covered by spousal exemption, no requirement to “ascertain” value for CGT purposes. Interest ‐ that accrued to date of death must be included as an asset of the Estate but at net value. Valuations ‐ quoted shares value at lower of: quarter up or averaged recorded bargains. Tax free legacies ‐ gross up not required as IHT due borne out of fully taxable residue. Nil Rate Band ‐ 07/08 thus £300,000 fully utilised against lifetime transfers. Discount ‐ related property rules apply so no discount on real estate. Matters which perhaps require further explanation or review: Wife’s domicile ‐ Review wife’s domicile position. Potential impact of reduced spousal exemption/gift with reservation of “Windsurf” if wife non UK domicile. Sample STEP Diploma level Taxation Question and Solution October 2012 Charity Due Date ‐ is it UK registered charity? ‐ was 31 August 2008 thus interest running on overdue IHT. 07/08 CGT Loss ‐ SA08 ‐ carry back on death, thus need to review earlier returns. finalise return. Due date of filing 31 January 2009, due date for payment 31 January 2009. Lifetime Gifts 1 Jan 2001: AE 00/01 99/00 PET value 30 Jun 2001: AE 01/02 00/01 PET value 30 June 2003: AE 03/04 02/03 PET value 31 Oct 2003: AE 03/04 PET value 31 May 2006: AE 06/07 05/06 CLT value 30 Nov 2007: AE 07/08 06/07 Marriage exemption 5,000
3,000
2,000
(5,000)
Nil
10,000
3,000
Nil
(3,000)
7,000
25,000
3,000
3,000
(6,000)
300,000
Nil
Nil
300,000
50,000
3,000
3,000
(6,000)
44,000
25,000
3,000
Nil
2,500
(5,500)
Sample STEP Diploma level Taxation Question and Solution October 2012 PET value Position on Death 30 June 2001 ‐ PET NRB Balance 30 June 2003 ‐ NRB Balance 31 October 2003 ‐ NRB Balance 31 May 2006 ‐ 30 Nov 2007 ‐ 19,500
£ 7,000 (7,000) Nil 19,000 (19,000) Nil 300,000 (274,000) 26,000 @ 40% (less taper) 44,000 @ 40% 19,500 @ 40% NRB 300,000 (7,000) 293,000 (19,000) 274,000 (274,000) IHT 6,240 17,600 7,800 Notes: 31 Oct 2003 Gift made 4 ‐ 5 years pre death thus taper relief applies to reduce IHT due by donee thus: 26,000 @ (40 x 60)% = 6,240 31 May 2006 Addition made post Mar 06 thus treated as CLT but value covered by available Nil Rate Band (£255,000) thus nil IHT paid on original transfer. Part (B) ‐ CG34 Procedures Purpose ‐ Intended to provide degree of certainty following the disposal of an asset by establishing an agreed CGT base cost where none has previously been determined i.e. Mar 82 value or more commonly, where an asset has been acquired on death in circumstances where nil IHT is involved by reason of exemption (spousal) or Estate level (within NRB threshold). Process ‐ Requires completion of form CG34 with submission to HMRC in advance of the relevant SA return recording disposal of the original acquired asset. The form requires details of both the tax payer and the transaction involved. This is not a frivolous process thus the detail, date and proposed valuation must be clearly stated. Sample STEP Diploma level Taxation Question and Solution October 2012 Importantly, it is necessary to submit the proposed CGT computation to include any claim to relief or exemption as well as valid supporting paperwork/description to include; formal valuation; details of acquisition/improvement costs; pertinent data that might affect the valuation, i.e. planning permission. Part (C) – Administration Period Year ended 5 April 2008 Income Tax ‐ Interest £3,000 @ 20% Due and payable 31 January 2009 Period ended 31 March 2009 Income Tax ‐ Interest £3,080 @ 20% Capital Gains Tax ‐ Meerkat Plc Green Ideas Ltd Monty Plc Annual exemption Net chargeable gain CGT thereon @ 18% Total Due and payable 31 January 2010 Administration Period – CGT Workings Meerkat Plc 10,000 @ 2.75 Cost (5.02.08) Net gain 03 Mar 2009 Green Ideas Ltd 1,000 @ 0.65 Cost (5.02.08) Net loss 30 Sept 2009 Monty Plc Cash take over Cost (5.02.08) 15,300
(7,350)
1,984
9,934
(9,600)
334
£
27,500
(12,200)
650
(8,000)
4,000
(2,016)
600.00 616.00 60.12 676.12 15,300 (7,350) Sample STEP Diploma level Taxation Question and Solution October 2012 Net gain 1,984 Note: 30 Sept 2009 Part disposal in relation to cash receipt requiring A/A+B formula. Where A = proceeds and B = value retained thus: 5,040 x 4,000/(4,000 + 6,000) Part (D) – Estate Income Distribution The Estate may be regarded as a conduit of income ultimately passed on to the underlying beneficiary once any tax thereon due at its normal tax date has been properly accounted for by the executors. An income distribution to a beneficiary is treated as an income for the year of receipt or if earlier, income for the year in which the Estate is wound up. Importantly, if an asset is transferred to a residuary beneficiary, then the value of the asset transferred is deemed to include the beneficiary’s share of accrued income up to the point of transfer. The source supporting the sum paid to the beneficiary must be identified such that the net payment received is subject to gross up at the appropriate rate. The payment is treated as first made out of income subject to tax at basic rate (i.e. rents), as second made out of income subject to the lower rates (e.g. interest) and finally out of dividend income with its non‐refundable credit. The income and tax credit is verified by form R185. Quoted/Unquoted Share Valuation Workings £
£ £50,000 @ 91p Dividend (£50,000 @ 5%/2 @ 80% x 97/181) £10,000 @ 122p £2,000 @ 252p Green Ideas Ltd Other 45,500
12,200
5,040
8,000
15,000
85,740
536 Sample STEP Diploma level Taxation Question and Solution October 2012