Category: Taxation

Taxation of UK Mutual funds

A simplified guide to HMRC rules for individual investors.

The tax rules aim to put the investor broadly in the same position as if they had invested in the fund’s assets directly (rather than investing in the fund)2.

Income

Investors may receive dividend distributions and/or interest distributions3:

  1. Dividend distributions are treated in the same manner as any other UK company dividend.

  2. From 6th April 2017 interest distributions are paid gross and taxed in the same way as interest income from a bank4. 

In case of an accumulating fund (instead of distributing dividends or interests it re-invests them in the fund) amounts reinvested are taxed as income (dividend or interest) accruing to investors in the same way as if they had been distributed. Remember to deduct these on sale when computing capital gains tax5.

Disposal

A sale will give rise to capital gain6.

Units are treated as shares in a company and capital gains tax is computed in a similar way7.

Bonus

  • In India tax rates for equity and debt funds differ, its not the case in UK.

Source:

  1. Tolly Tax Guide: 37.27 to 37.28
  2. IFM01000
  3. IFM03110
  4. IFM03350
  5. IFM03120 and CG57707
  6. CG57680P
  7. CG57682 and CG57751.
  8. Detailed information given in Investment Funds Manual.
  9. To know about offshore/Indian Mutual funds [click]

How Capital Allowance interact with Capital Gains Tax

This article explains how capital allowance effects capital gains calculations.

A common occurrence in trading businesses is sale of plant & machinery or vehicles used in the business. Rules shown below are applicable both in moveable and fixed plant & machinery.

Two scenarios could happen:

  1. Disposal proceeds are less than purchase cost – a loss (usual case)
  2. Disposal proceeds are less than purchase cost – gain

We will try to explain these scenarios, by way of an example.

We need to prepare two calculations – one for capital allowance (CA) and other for capital gains.

X is an individual trader for many years. He brings forward main pool expenditure of £40k. In year 1, he buys a van for £20k and a computer for £5k. He claims AIA on all expenditure. In year 2, he sells the van for £12k and the computer for £8k.

We have illustrated below, how these transactions will affect the Capital Allowance and Capital Gains calculations.

Capital Allowance calculation

Year 1                                                                          Main pool                                        
WDV b/fwd                                                                  40,000
Additions                                                                     25,000
AIA                                        25,000                                                              
                                                                                         40,000
WDV 18%                                                                       7,200                                                              
WDV c/fwd                                                                   32,800

Year 2
WDV b/fwd                                                                   32,800
Disposal value                                                             17,000 a
                                                                                          15,800
WDV 18%                                                                      2,844                                                              
WDV c/fwd                                                                   12,956

a. Disposal value = £12k (van) plus £5k (computer), as disposal value is restricted to original purchase cost.

Capital Gains Calculation

Capital gains is only applied on assets if sold above its original purchase price. Thus, van is ignored for Capital Gains.

                                                                                   Computer b         
Disposal proceeds                                                 8,000
Purchase cost c                                                        5,000
Unindexed Gain                                                      3,000
Indexation allowance (estimated)                 (500)
Indexed Gain                                                             2,500

Note:

b. Gain or loss is computed on each asset individually.
c. Capital allowance taken on assets are completely ignored. TCGA 1992 sec 41

Practice notes:

  1. We should keep note of each item added to the pool – date added/purchased and amount added. Date is important as companies get indexation allowance for items purchased before 31st December 2017. Usually, commercial tax filing software will have the facility to record assets individually and calculate indexation allowance.

Source:

  1. Book – Taxation by Alan Melville
  2. Book – Tolley’s Tax Guide para 22.19, 22.46 and 38.4

Bonus:
1. In case X sells a table to his friend for £1k (market value £2k). Disposal value will be £1k if his friend runs a trading business where he can claim Capital Allowances . In case his friend does not run a trading business and cannot claim Capital allowances disposal value will be £2k.

2. In case X gifts the table to his employee, disposal value will be nil. But tax maybe payable by employee under ITEPA 2003.

3. In case X gifts the table to his brother, disposal value will be £2k (market value).

See HMRC Manual CA23250 on disposal values.

Profit extraction via interest on Director loan account

Small company owners can lower their tax bill by charging interest to their own companies.

Where company owes money to shareholders. Shareholders can charge interest to the company on the outstanding loan balance.

In case interest is charge on a loan for a period less than a year there is no need to deduct tax and complete form CT61.1

Interest rate should be a commercial rate i.e. few points above BOE base rate. In case, rate charged is too high HMRC can treat it as remuneration or dividend.1

Company gets relief in the accounting period when interest is actually paid or within 12 months after its end. So simply crediting interest amount in Director Loan Account will not work.2

Interest Income received by the director will be added to his taxable income but it is taxed on receipt basis.2

Main advantage of this interest over dividends is:

  • No tax on starting rate of savings upto £5,000. So directors save income tax.
  • Company gets deduction for interest paid.

Notes on form CT61

  • In case loan is for a period over one year, 20% (basic rate) tax will need to deducted and deposited with HMRC using Form CT61.
  • CT61 returns are filed every quarter.
  • Nil returns not needed.
  • Return cannot be downloaded. A structured email needs to be sent to HMRC; they will send the form in post.
  • Both Returns and Tax deducted are due within 14 days from the end of the return period.
  • Company can issue Form R185 to the person whose tax has been deducted.

Source:
1. Para 1.148 Bloomsbury Tax Planning Book.
2. Para 2.47 Peter Rayney’s Tax planning for owner managed companies.

Compulsory purchase of land in India and second Private Residence Relief

This article focuses on compulsory purchase of land in India, basic concept is same in case land is situated in any country including UK.

Background

Our client’s ancestral home was partly acquired by the government in India to widen the road. Client lives in UK, but the Indian house is occupied by his widowed mother.

What is compulsory purchase of land?

Compulsory purchase is where land is acquired by an authority possessing compulsory purchase powers. Example a highway is being broadened and government acquires part of your front garden.  Compensation received from authority is `sale proceeds` in this case. [see CG72100]

What is the date of disposal?

Date of disposal is date when compensation is agreed. [see CG72101]

Does land in India treated as same as land situated in UK?

UK Capital Gains Tax is not normally dependent on where in the world an asset is situated but there are some exceptions to this rule. [see CG12400P] These exceptions are not applicable in our case, as client is tax resident in the UK.

Since 6 April 2020 , individuals (not companies) selling UK land need to report and pay capital gains tax to HMRC within 60 days. Overseas land disposals are reported in Self-assessment tax return only. Source Litrg.org.uk.

Are there any reliefs available?

Yes, besides the usual CGT reliefs (like EIS investment etc.) there are three reliefs available:

  1. Small disposal relief

Where disposal proceeds are less than £3,000 or 5% of the Market Value of the land. No gain arises and compensation is deducted from the purchase cost. [see CG72200]

2. Roll over relief

Simple guidance on this relief is given in HS290 ; for detailed guidance see CG61900P.

Basically, if sale proceeds are used to acquire another land, capital gain tax can be deferred.

Conditions:

  1. New land must not be used as tax payers main residence within 6 years from date of acquisition. [section 13 HS290].

[Practice notes – Where new land is acquired which seems suitable for use as a private residence by the new owner but which at the time of the roll-over relief claim is not used as a private residence by the owner, a forward note should be made to review the position at, say, the three or six year points after the date of acquisition in order to ensure that the property has not become the only or main residence of the landowner.] [see CG61906]

  • Period of reinvestment 12 months before, or 36 months after the disposal of the old asset.

This relief – you can be claimed provisionally as well.

How to claim this relief? See section 18 and 19 of Helpsheet HS290 also see Example 17 and 18 for computation of relief.

3. Principal private residence relief (PPR).

Simple guidance on this relief is given in HS283 ; for detailed guidance see CG64200c.

If you dispose of a house which was any time your main residence you get this relief. If the dwelling house has not always been your only or main residence, you will need to split the gain as [Period of occupation1 + final 9 months2] / [Period of ownership1].

  1. Both period of occupation and ownership starts from 31st March 1982 if property owned before this date.
  2. The final 9 months of your period of ownership always qualify for relief, regardless of how you use the property in that time, as long as the dwelling house has been your only or main residence at some point.

Residence provided for a dependent relative – Second PPR Relief

A second PPR relief may be available on disposal of a residence which was provided to a dependent relative if certain conditions are fulfilled see [CG65550+.] . Main condition is that the residence was acquired for the dependent relative before 6th April 1988.

Conclusion:

In our case, as interest in the property was acquired by tax payer and his widowed mother before 1988 and they also full filled other conditions. So no Capital Gains Tax was payable.

For further reading on UK India taxation see our Worldwide blog

Incorporating a letting business

Should I transfer my existing properties in a new company ?

Three taxes are considered when considering the question of incorporating a letting business:

  1. Corporation/Income Tax
  2. Capital Gains Tax ; and
  3. Stamp Duty Land Tax (SDLT)
  4. Inheritance tax

1. Corporation/Income Tax

  • Corporation tax rates are lower than income tax rates
  • Continued tax relief on mortgage interest
  • Flexibility in timing of profit extraction.

2. Capital gains tax (CGT)

Transfers between connected parties are deemed at market value (MV).`Incorporation relief ` is available but it will only be available in case of a `business`. Keeping in view case law as in Lord Fisher and Ramsay, it will be a difficult threshold to cross for landlords with one or two BTL properties.

Incorporation relief

No CGT payable if transfer is for shares in the business.

Eligibility conditions:

  • Rental activity is a business. Main case law here is `Ramsay Vs HMRC` to determine whether the activity is really a business. HMRC guidance CG65715 states the activity should be carried for around 20 hours a week personally.

    Please note HMRC no longer provides non-statutory clearances as conformation that a particular property letting is sufficient to qualify as a business. 

  • Consideration in new issued shares only – not a credit in director’s loan account.
  • Transferred as a going concern i.e. profitable business.

Please note annual exemption allowance, currently £11,700 not available to companies

3. SDLT – Usually SDLT is not payable when consideration is nil. But FA 2003 Sec 53 also see SDLTM30220 inserted a special provision to ensure SDLT is payable on Market Value, irrespective of consideration actually paid. 

Future purchase – In case buyer is a company it pays 3% surcharge (threshold £40k) in all cases, whether or not company owns another property or not. Thus landlords cannot avoid the 3% surcharge by buying properties via company.

Also, be aware of 15% SDLT rate for companies but relief maybe avaliable for rental business.

SDLT Calculator

4. Inheritance tax : Property will be a chargeable asset for both individual or owned by a company, as Business Property relief not available see IHT Act 1984 sec 105 (3)

Practical considerations:

  • Refinance costs
  • Increase in interest rates – as bank usually charge more to limited company landlords.
  • Huge SDLT bill on transfer of assets.
  • Other fees – Lawyer, accountant, valuer etc.

Lastly, there is no guarantee HMRC will not change the rules for finance costs relief for companies in the future.

Conclusion:

I think the sensible approach will be to leave the existing portfolio as it is but to buy new properties in a limited company if the aim is to expand the portfolio rather than profit extraction from the business. This will require another article in greater detail.

 

First written in May 2018; updated March 2023