Capital Investment Bond (chargeable gain math question)

mania112

I'm training for a Finance exam and i'm looking at a practice question, that i'm not sure about - even when I have the answer in front of me too, take a look:

Describe the 5% allowance system for Capital Investment Bonds.
• 5% of the initial premium is available each POLICY year
• If not used can be carried forward to subsequent years
• No chargeable event occurs if withdrawals are kept within these allowances
• The limit is 100% of original premium, therefore 5% for 20 years, or 4% for 25 years
• If 100% is exceeded any subsequent withdrawals are chargeable events
• If accumulated allowances are exceeded, then the excess ‘potentially’ taxable to INCOME TAX at the higher rate (onshore bond) or marginal rate (offshore bond).

Fine i'm happy with that, so then:

Your client has held an ONSHORE Capital Investment Bond for the last 8 years. The Investment history is shown below.

1) Calculate the ’gain’ & the amount of tax that would be paid if your client was a higher rate tax payer throughout the term of this contract.

INITIAL INVESTMENT £20,000 (5% = £1,000)

YEAR WITHDRAWN CHARGEABLE GAIN
1........NIL...........................NO
2........£1,500......................NO
3........£1,500......................NO
4........£3,000......................£2,000
5........£1,000......................NO
6........£1,000......................NO
7........NIL...........................NO
8........FULLY ENCASHED FOR £22,000

So the tax charge before the full encashment is £400, no problems there.

Now, the gain I have at full encashment is £6,000.

£30,000 (final value plus withdrawals)
LESS
£20,000 (initial sum)
LESS
£2,000 (gain already charged for)
LESS
£1,000 (5% carry over from year 7)
LESS
£1,000 (5% allowance for year of enchashment)

The 'textbook' answer however says £7,000. Where have I gone wrong?

bigadaj

Aren't the gains in years two and three chargeable, two times £500 would then give you the extra grand.

JohnRo

The only explanation I can come up with is that of the £10,000 net gain on the bond all of the £3000 withdrawn in year 4 was taxed?

Because the year 4 withdrawal exceeds the 5% rule all of that money withdrawn is classed as a chargeable event which would then leave just £7000 of the £10,000 gained in total remaining to be taxed.

I don't actually know if that is the correct explanation btw.

jem16

bigadaj wrote: »

Aren't the gains in years two and three chargeable, two times £500 would then give you the extra grand.

No they aren't because of the carry forward rule. By end of Year 3 a total of £3000 could be withdrawn with no chargeable gain.

JohnRo wrote: »

The only explanation I can come up with is that of the £10,000 net gain on the bond all of the £3000 withdrawn in year 4 was taxed?

Because the year 4 withdrawal exceeds the 5% rule all of that money withdrawn is classed as a chargeable event which would then leave just £7000 of the £10,000 gained in total remaining to be taxed.

Again no because of the carry forward rule. By end of Year 4, £4000 could have bneen withdrawn with no chargeable gain. As £6,000 was withdrawn in total, this created the chargeable gain of £2000.

jem16

mania112 wrote: »

The 'textbook' answer however says £7,000. Where have I gone wrong?

The only answer I can come up with is that the encashment happened before the 8th year anniversary so you can't count the final £1k allowance.

mania112

jem16 wrote: »

The only answer I can come up with is that the encashment happened before the 8th year anniversary so you can't count the final £1k allowance.

yeah, in the exam i wouldnt be confident putting anything other than £6,000 though - hopefully i'll get lucky with the multiple choice and i can figure out which one is right (if this was the question, i hope £6k isn't an option!)

You can surely still have a 5% allowance in the year of encashment becuase an investor might take 5% one month and the remainder later in the year.

I think the text is wrong to be honest. It's written by a trainer, rather than CII or anyone, so it's not out of the question.

Stochasticity

mania112 wrote: »

Now, the gain I have at full encashment is £6,000.

£30,000 (final value plus withdrawals)
LESS
£20,000 (initial sum)
LESS
£2,000 (gain already charged for)
LESS
£1,000 (5% carry over from year 7)
LESS
£1,000 (5% allowance for year of enchashment)

The 'textbook' answer however says £7,000. Where have I gone wrong?

To begin with, you can't deduct the five percents.

Nevertheless, I still can't see a way to £7,000.

I make the answer to be £8,000.

See page 20: http://www.hmrc.gov.uk/helpsheets/hs320.pdf

(£22,000 + £8,000) - (£20,000 + £2,000) = £8,000

mania112

Stochasticity wrote: »

To begin with, you can't deduct the five percents.

Nevertheless, I still can't see a way to £7,000.

I make the answer to be £8,000.

See page 20: http://www.hmrc.gov.uk/helpsheets/hs320.pdf

(£22,000 + £8,000) - (£20,000 + £2,000) = £8,000

I agree that it's a typo on the answer and I now agree the answer is £8k, the 5% doesnt roll over on full encashment and in the last year there's not a whole year - it's during the 8th year.

Thanks all... perhaps a step closer to a pass (R02 is the exam for those in the same boat - a killer for a rookie like me!)