Your manager has been advising a client, Waverley, on his plans to sell his business. An email from your manager setting out the current situation and some notes on the tax system in the country of Surferia are set out below:
Email from your manager – dated 8 September 2016
|
Waverley Waverley was born in 1976. He divorced his wife in 2014. His three children, all of whom are under 18, live with his ex-wife in the UK. Waverley began trading as a sole trader on 1 March 2008. We are advising him on the sale of this unincorporated business with the objective of minimising his capital gains tax liability. It has been concluded that it will be very difficult to sell the business as an unincorporated entity, so Waverley is going to sell the business to a newly-formed company which he owns, Roller Ltd. Waverley will then sell his shares in Roller Ltd. Waverley has decided to emigrate to the country of Surferia. He wants to make a fresh start and has heard from friends that moving abroad could be advantageous from the point of view of UK tax. He will move to Surferia on 5 April 2017. Waverley wants to see his children regularly and is also an enthusiastic member of an amateur football team in the UK. As a result, he intends to spend as many days as possible in the UK in the tax year 2017/18. He will continue to work for Roller Ltd until the company is sold and it is also possible that the purchaser of Roller Ltd will ask Waverley to do further work for the company whilst he is in the UK. Waverley will sell his home in the UK in March 2017. The house is Waverley’s principal private residence, such that there will be no capital gains tax in respect of its disposal. Once the house has been sold, whenever Waverley is in the UK he will stay in a hotel, as he does not have any other UK property available for his use. When he is not in the UK, he will live in a new house which he plans to buy in Surferia. Unincorporated business Waverley will cease trading as a sole trader on 15 January 2017 when he sells his unincorporated business to Roller Ltd. Roller Ltd will be wholly-owned by Waverley. The tax adjusted trading profits of the business (actual and budgeted) up to the date of cessation are: Year ended 30 June 2016 £125,400 Period ended 15 January 2017 £72,150 The assets of the unincorporated business are expected to be worth £540,000 on 15 January 2017. They will be sold at market value to Roller Ltd in exchange for 270,000 £1 ordinary shares in the company. This will result in chargeable gains, before incorporation relief, of £160,000 on the business premises and £30,000 in respect of goodwill. The shares in Roller Ltd will be sold for £600,000 at some point during the six months following Waverley’s emigration to Surferia on 5 April 2017. Residence status Waverley has always been resident and domiciled in the UK, but it is likely to be beneficial for him to be non-UK resident for the tax year 2017/18. Investment property Waverley owns an investment property located in the UK. The property is a residential house, which is tenanted under a lease which expires on 31 October 2021. This house has never been Waverley’s principal private residence and it is not available for him to use. Waverley plans to sell this house as soon as possible following the end of the lease. He will then give the proceeds from the sale to his sister. |
Email from your manager – dated 8 September 2016 (continued)
|
Please carry out the following work: (a) Unincorporated business – State the basis period for 2016/17, the final tax year of trading, and calculate the taxable trading profits for that year, noting any further information required in order to finalise this figure. – State the conditions which must be satisfied in order for incorporation relief to be available on the sale of the unincorporated business to Roller Ltd. – Prepare calculations in order to conclude whether or not it will be advantageous for Waverley to disclaim incorporation relief on the sale of the unincorporated business to Roller Ltd. To do this you will need to calculate Waverley’s total capital gains tax liability, in the UK and in the country of Surferia, in respect of both the sale of the unincorporated business to Roller Ltd in the tax year 2016/17 and the sale of the Roller Ltd shares in the tax year 2017/18. In respect of the sale of the Roller Ltd shares, you should consider two possible situations: first where Waverley is resident only in the UK at the time of the sale; and second where he is resident only in Surferia at the time of the sale. You should not consider the rules concerning individuals who are temporarily non-UK resident. You should assume that Waverley will be a higher rate taxpayer in the tax years 2016/17 and 2017/18 (if UK resident) and that he realises sufficient additional chargeable gains every year to use his annual exempt amount. (b) Residence status Explain the maximum number of days which Waverley will be able to spend in the UK in the tax year 2017/18 without being UK resident. I have already concluded that for the tax year 2017/18, Waverley will be neither automatically resident overseas nor automatically resident in the UK. (c) Investment property – Explain the capital gains tax implications in the tax year 2021/22 of the sale of the investment property, assuming that it gives rise to a chargeable gain and that Waverley is resident only in the country of Surferia in that tax year. – Discuss, by reference to Waverley’s domicile status, whether or not Waverley’s gift to his sister of the proceeds from the sale of the investment property will be within the scope of UK inheritance tax. Tax manager |
Notes on the tax system in the country of Surferia
|
– Individuals who are resident in Surferia are subject to capital gains tax on disposals of worldwide assets at the rate of 12%. There is no annual exempt amount. – For the purposes of capital gains tax in Surferia, Waverley’s chargeable gains will be the same as they would be in the UK. – The payment date for capital gains tax in Surferia is the same as the payment date for capital gains tax in the UK. – There is no inheritance tax in Surferia. – There is a double tax treaty between the UK and Surferia. |
Required:
Carry out the work requested in the email from your manager. The following marks are available:
Unincorporated business.
Unincorporated business
Final tax year of trading
The basis period for 2016/17, the final tax year of trading, is from 1 July 2015 to 15 January 2017. Accordingly, the taxable trading profit will be £197,550 (£125,400 + £72,150).
Any overlap profits from when Waverley began trading are deductible from this figure; this information is required in order to finalise the taxable trading profit.
Incorporation relief – conditions
– Waverley’s unincorporated business must be transferred to Roller Ltd as a going concern.
– All of the assets of the unincorporated business, other than cash, must be transferred.
– The whole or part of the consideration for the transfer must be the issue of shares by Roller Ltd to Waverley.
Sale of the unincorporated business to Roller Ltd and subsequent sale of Roller Ltd
Disclaim incorporation relief
Sale of the unincorporated business to Roller Ltd (2016/17)
Residence status
Residence status
The number of days which Waverley can spend in the UK in 2017/18 without being UK resident will depend on the number of ties he has with the UK.
Waverley will definitely satisfy two ties:
– He was in the UK for more than 90 days in 2016/17, the previous tax year.
– In 2017/18 Waverley will have children under the age of 18 who are resident in the UK.
Waverley will also satisfy a third tie if he works in the UK for 40 days or more in 2017/18.
Waverley will not satisfy the following two ties in respect of 2017/18:
– He will not have accommodation in the UK available for his use.
– He will not be in the UK for more days than in any other country
Accordingly, Waverley will satisfy either two or three ties
Waverley was UK resident in the previous three tax years. Accordingly, if he works in the UK for 40 days or more, such that he satisfies three ties, he will only be able to spend up to 45 days in the UK without becoming UK resident.
If Waverley does not work in the UK for 40 days or more, he will only satisfy two ties, and will therefore be able to spend up to 90 days in the UK without becoming UK resident.
Tutorial note: The question states that Waverley will not be automatically UK resident in the tax year 2017/18. Accordingly, he must be in the UK for less than 183 days. The question also states that he will live in Surferia when he is not in the UK. Accordingly, he will spend more days in Surferia than he will in the UK.
Investment property.
Investment property
CGT
The gain on the sale of the property will be subject to Surferian CGT because Waverley will be resident in Surferia when he sells the property.
That part of the gain which has accrued since 5 April 2015 will also be subject to CGT in the UK because residential property situated in the UK is subject to UK CGT regardless of the residence status of the person making the disposal.
It will therefore be necessary to consider the terms of the double tax treaty between the UK and Surferia. For example, the treaty might provide that the part of the gain on the property which would otherwise be taxed twice is only taxed in one of the two countries (double tax relief by exemption). Alternatively, it might allow the tax chargeable in one country to be deducted from the tax charged in the other (double tax relief by credit).
Inheritance tax (IHT)
Whether or not Waverley’s gift to his sister will be within the scope of UK IHT will depend on Waverley’s domicile status and the country in which the money is situated.
If the money is in a UK bank account it will be a UK asset, such that the gift will be within the scope of UK IHT regardless of Waverley’s domicile status. If the money is in an overseas bank account it will be an overseas asset, such that it will only be subject to UK IHT if Waverley is domiciled or deemed domiciled in the UK.
In order to acquire a domicile of choice outside the UK, Waverley will need to leave the UK permanently and sever all of his links with the UK. Accordingly, whilst he has young children in the UK, and wishes to continue with his UK-based social activities, he will remain domiciled in the UK even though he will be living overseas.
In addition, even if Waverley were able to acquire a domicile of choice overseas, such that he loses his UK domicile status, for the purposes of IHT he will be deemed domiciled in the UK for a further three years and for any year where he has been UK resident for 17 out of the 20 years prior to the gift.
In conclusion, the gift of the proceeds from the sale of the investment property will be within the scope of UK IHT unless Waverley has acquired a domicile of choice overseas and is not deemed domiciled in the UK for the purposes of IHT.