Allowances, exemptions or reliefs
I have only just started looking at income tax and I am already confused by the different terminology that seems to relate to that tax-free element. What do the terms allowance, exemption and relief mean?
Troubled by terminology
Caron writes: The terms are used in many of the other taxes as well. My best tip is to remember to refer to the Tax Rates and Allowances that are provided in the exam room, as that will help you to identify which one to use and where. Let’s look at an example of each:
• A personal allowance (PA) is the threshold up to which no income tax is payable. It’s the tax-free deduction from an individual’s net income. Above the PA limit, the balance is taxable.
• Interest on an ISA is exempt. If the account has been set up as an ISA, then the criteria has been met for the interest to not be taxable and it has no impact on the savings rate bands.
• Rent-a-room relief allows the taxpayer to choose whether to calculate the taxable income from renting a room in their house as normal, or whether to just tax all rental income over and above the £7,500 tax-free portion.
• All have the same effect of reducing the amount of income that remains taxable.
When do I use IHT or CGT?
In a question a gift was made of a house to a connected person and I correctly used the open market value (OMV) for the disposal proceeds. But then I was stumped. Should I be working out IHT, CGT or both. How do I know?
Doubting my decision
Caron writes: In this TX exam the multi-tax questions are quite straight forward. The examiner writes: “Although the interaction of IHT and CGT is not examinable at TX (UK), the two taxes could be examined within the same question… and where a question covers more than one tax you will be given clear guidance notes as to exactly which taxes you need to consider.”
Therefore, in the example you quote, the question will state which tax you are expected to calculate. Do take care as you may need to value items differently for each tax. For example, the IHT transfer of value will be based on the diminution in value of the donor’s estate and with unquoted shares that may not be the same as the OMV. Follow the golden rule of reading the question carefully.
Too many rules to learn
I am really struggling to understand the detailed rules in the tax administration section – which are different for individuals and companies! Do you have any tips on how to remember them?
Daunted by details
Caron writes: This is a common problem and the answer is repetition, repetition, repetition. Try preparing a table summarising the key dates and rates. Do lots of question practise where you apply the rules to different scenarios.
Remember to produce full, written answers as these can appear as a constructed response question. And check carefully what you have been asked to calculate. Remember that interest is charged because the HMRC have received the tax late and penalties are charged for failure to comply.
What’s a ‘thinking’ question
What does it mean when the examiner talks about a ‘thinking’ question?
Caron writes: These questions often appear as the 10-mark question in Section C. You’ll recognise them because the question will require you to “calculate the reduction in x’s income tax liability…” or “determine if there will be an overall saving of tax…”. That means you will be expected to advise on the tax implications of a change in circumstances.
For example, a director/shareholder may be considering a switch from remuneration to dividends and wants to know the tax and NI implications. Often these can be follow-on questions worth only a few marks.
Rather than doing lots of lengthy calculations, if you think more and write less you can identify how to work out the tax implications of the marginal changes only. Practising these types of questions will help you to save time in the exam.
• Caron Betts is an ACCA tutor at AVADO