Bex has recently left employment and entered into a business partnership with Amy. Bex requires advice in respect of a loan to the partnership, the calculation of her share of profits and the tax treatment of her redundancy payment.
Bex:
– Is resident and domiciled in the UK.
– Received an annual salary of £120,000 from her former employer, Cape Ltd.
– Was made redundant by Cape Ltd on 30 September 2015.
– Joined Amy, a sole trader, to form a partnership on 1 January 2016.
– Has no other source of income.
Amy and Bex partnership:
– Will prepare its first set of accounts for the 16-month period to 30 April 2017.
– Is expected to make a tax-adjusted profit of £255,000 (before deducting interest and capital allowances) for the period ending 30 April 2017.
– The tax written down value on its main pool at 1 January 2016 is £nil.
– Except for the computer referred to below, no further assets will be purchased by either Amy or Bex for use in the partnership in the period ending 30 April 2017.
Profit sharing arrangements:
– The partnership’s profit sharing agreement is as follows:
Amy Bex
Annual salary £nil £30,000
Profit sharing ratio 3 : 1
Bex – loans:
– In addition to her capital contribution, Bex will make a £20,000 loan to the partnership on 1 August 2016. The partnership will use this money wholly for business purposes.
– This loan will be financed by a £25,000 personal loan from Bex’s bank, taken out on the same date.
– The remaining £5,000 of the bank loan will be used to purchase a computer for use in the partnership. Bex will have 20% private use of this computer.
– Both the loan from Bex to the partnership and the personal bank loan to Bex will carry interest at the rate of 5% per annum.
Bex – redundancy package from Cape Ltd:
– The package comprised a £22,000 statutory redundancy payment and an additional ex-gratia payment of £48,000.
– Bex also received three months’ salary in lieu of notice, as specified in her contract of employment.
Required:
(i) Explain, with the aid of calculations, the tax deductions which will be available in respect of the loan interest payable on both the loan from Bex to the partnership and the personal bank loan to Bex.
(ii) In respect of the period ending 30 April 2017, show the allocation between the partners of the taxable trading profit of the partnership.
(iii) Calculate Bex’s taxable trading income in respect of her share of the partnership profits for all relevant tax years.
Note: Your answer to (a)(iii) should clearly state the tax years and basis periods involved.
Amy and Bex
(i) Tax treatment of the interest payable
The interest payable by the partnership on the loan from Bex will be deductible in calculating the taxable trading profit of the business.
As the loan will be made on 1 August 2016, the interest payable in the period ending 30 April 2017 will be £750 (£20,000 x 5% x 9/12).
The interest payable on the loan taken out by Bex to provide the loan to the partnership will qualify for income tax relief as it is a loan for a qualifying purpose. The annual deduction from Bex’s total income will be £1,000 (£20,000 x 5%), and the deduction in the tax year 2016/17 will be £667 (£1,000 x 8/12).
The purchase of a computer for use in a partnership is also a qualifying purpose for income tax relief, but the interest payable is only allowable for three years from the end of the tax year in which the loan was taken out, i.e. up to 2019/20. The allowable amount is also restricted where there is private use of the asset by the partner.
Bex will get a deduction against her total income of £133 (£5,000 x 5% x 80% x 8/12) in the tax year 2016/17 and an annual deduction of £200 (£5,000 x 5% x 80%) in each of the tax years 2017/18, 2018/19 and 2019/20.
(ii) Allocation of taxable trading profit
Explain the income tax implications for Bex of the receipt of the redundancy package from Cape Ltd and calculate her total income tax liability for the tax year 2015/16.
Bex – redundancy package from Cape Ltd
The statutory redundancy pay is fully exempt from income tax. However, it reduces the £30,000 exemption available for the ex-gratia payment.
The taxable amount of the ex-gratia payment is therefore £40,000 (£48,000 – (£30,000 – £22,000)).
Three months’ pay in lieu of notice (PILON) is £30,000 (£120,000/4). This is fully taxable as earnings as Bex was contractually entitled to it.
Bex – income tax liability 2015/16
