Julia and Samantha are both 21 years old and graduated with First Class degrees from Hull University Business School in 2021. Julia studied Accounting and Samantha studied Marketing. They are good friends and shared a house with some other students whilst at University. They have both now gone their separate ways although they have kept in touch with each other and managed to meet up a few times since leaving. They regularly chat to each other about career progression and ask for each other’s advice on various financial matters.
Julia started a job as a trainee accountant with the Hull office of ASD LLP (ASD), a national firm of Chartered Accountants, on 1 July 2021. Her gross starting salary was £30,000 a year and she was automatically enrolled in ASD’s occupational pension scheme, contributing 12% of her salary. ASD have also included Julia in their group health insurance scheme and the firm will pay the annual premium of £710. Julia’s student loans for tuition and maintenance amounted to approximately £51,000 when she graduated. HMRC have issued a PAYE Code of 1257L but, having taken a Taxation module as part of her degree, Julia does not think this is correct bearing in mind she had earnings whilst still a student, her pension contributions, her benefit in kind and her student loans. She is worried that she may not be paying enough tax and she may get a large bill after the end of the tax year.
Julia is sharing a rented house with three other young professionals, but she hopes to be able to buy a small house or flat of her own very soon. She likes the Victoria Dock area of Hull and this would be convenient for work as it is within walking distance or a short commute. She has had a look on the Rightmove website and thinks she could find a two bedroomed house for about £135,000, or a flat for around £105,000. She has managed to accumulate savings of £5,000 in an ISA and she thinks her parents would lend her some more money towards a deposit. She is vaguely aware that there are other costs involved in purchasing your own property and living alone, but she hasn’t really thought about this seriously. Her Mum mentioned a washing machine and cooker the other day and she realises now that she may need to purchase other items such as a bed, a table and chairs as the house or flat is unlikely to be furnished.
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Julia managed her finances quite well whilst she was a student. She had a part-time job in Sainsbury’s and prior to starting her new job she earned a total of £2,400 between 6 April 2021 and 30 June 2021. No tax was deducted as her earnings were too low. Now she has started her new job and she knows she will have to budget carefully if she is to be able to buy her own property. She has given some thought to the likely costs of living on her own (apart from mortgage costs) and has come up with the following monthly figures:
Julia – anticipated monthly expenses
Travel 90 Food and cleaning materials 180 Council tax 85 Water 20 TV Licence 12 Heating and lighting 70 Phone and broadband 50 Subscriptions (Netflix, Spotify, Prime etc) 25 Clothes 100 Going out 80 Sundries (gifts for family and friends, one-off items) 75 Savings (rainy day fund) 100
Julia deals with all of her financial affairs via the internet, using online banking and various apps, and makes payments for everyday expenditure using her smartphone or the contactless facility on her debit or credit card. She doesn’t usually ask for or keep receipts from supermarkets, coffee shops, bars or other outlets that she visits. Just recently she has been really busy with her new job and her active social life and hasn’t got around to checking her bank or credit card transactions. She still receives paper bank and credit card statements through the post, as well as notifications from HMRC (she hasn’t got around to telling these organisations that she doesn’t need them anymore) and they are accumulating unopened in the vestibule of her block of flats, which is open to the general public. She has every intention of sorting all of this out when she has a spare Saturday afternoon, but things always seem to happen that take precedent. Recently Julia bought a new mobile phone and has yet to set a password/code on it.
Samantha also has well-advanced plans but they are rather different to Julia’s. She has always wanted to work for herself instead of being employed by someone else. She started her own business “The Cocoa Hut” whilst at university, creating and delivering gifts made from chocolate bars such as ‘bouquets’ and ‘party bags’. This has proved to be quite successful, and she anticipates that her accounting profit for the year ended 31 March 2022 will be approximately £11,500. This figure (which Samantha calculated herself) is after deducting the following items as expenses:
Depreciation of van 3,750 Samantha’s Income Tax and National Insurance Contributions (2020-21) 2,300 Samantha’s cash drawings of £320 a week 16,640
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Samantha doesn’t think that she will have to pay any 2021-22 income tax based on these figures, because her accounting profit is less than the Personal Allowance. She has been chatting to Julia (who, as explained above, achieved a First in her BSc Accounting degree) over a drink in the pub. Julia has been trying to explain to Samantha that in fact she will have some tax to pay, as well as some NI contributions, because her accounting profit will have to be “adjusted” for tax purposes. The adjustments will include Capital Allowances for the van (see below).
The van has been painted in bright colours and shows the logo of the business as well as all Samantha’s contact details. It was purchased brand new on 1 June 2020 for £15,000. Samantha uses it 70% for the business and 30% privately, and this proportion has been agreed with HMRC. On professional advice, for tax reasons Samantha did not claim Annual Investment Allowance (AIA) on the original purchase in 2020-21, only Writing Down Allowance (WDA) of 18% (adjusted for private use). Julia has told her that she can deduct WDA of £2,214 this year and has shown her this calculation:
Use % deductible
Original cost 01.04.2020 15,000
WDA @ 18% (2,700) 30% 1,890 Balance carried forward to 2021/22 12,300
WDA @ 18% (2,214) 30% 1,550 Balance carried forward to 2022/23 10,086
One of Samantha’s friends has asked her whether she has considered setting up as a limited company with her as the main director and shareholder. They have told her there are several benefits to running your business via a limited company including simpler tax rules (as she would be treated as an employee of the company) and various other benefits. Samantha is totally confused by all of this “accounts speak” but does wonder whether she would benefit from setting up and trading as a limited company.
Samantha is living with her parents in Walkington. She moved back in with them and her younger brother and sister after graduating and leaving the shared student house. She runs the business from her bedroom, the kitchen in the family home and has taken over the garage and her Dad’s shed for storing stock and packaging materials. She doesn’t pay any rent or contribute towards food or household costs. Despite being very generous and wanting to support her in her business, her parents are getting a bit impatient with Samantha’s attitude to money and think it is time she “stood on her own two feet”. She can be rather thoughtless and selfish, taking the rest of the family for granted. Samantha is still living the University life but without the need to do any University work, at the expense of her family.
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Samantha has now realised that she needs to reorganise her business and private life and be more considerate to her family. Despite running a profitable business and having no living costs for the past year she does not have any savings at all. She now thinks that she needs to raise some finance so that she can rent or buy some cooking equipment, office and storage space for the business, perhaps with living accommodation above so that she can move out of the family home. Her parents cannot afford to lend or give her sufficient money for this purpose so she is considering other options. The following sources of funds have passed through her mind:
Secured bank loan
Unsecured bank loan
0% credit card
Borrow from Grandma
Borrow from friends
Recently Samantha met a man in a pub who asked her if she would consider including £1,000 a month of his cash in her takings through the business. He said he works in the drinks industry and is only ever paid by the pubs in cash. He said has never been given a National Insurance number and therefore is not able to pay tax on his earnings himself. If Samantha would put the £1,000 a month through her business and pay all the tax due on it he will pay her £100 a month. She would therefore give him the £1,000, less the tax, less the £100 every month. Samantha was assured that this procedure was entirely legal and that there were no risks involved, financial or otherwise. All she would be doing would be paying the tax that he would have paid anyway. Samantha is quite intrigued by the idea as there doesn’t seem to be much time input needed, and as explained above she is in need of some additional funds. She is thinking about doing as he suggests.
END OF CASE STUDY
The requirements for the assignment are shown on the next page
(a) Prepare an income tax computation for Julia for 2021-22, taking into account her earnings from various employments, pension contributions and benefit in kind. Calculate her income tax liability for the year. Calculate her monthly employee National Insurance Contributions. From the figures you have prepared calculate her monthly “take home pay” from the date she commenced his employment with ASD. Explain how the PAYE code issued by HMRC has been computed and whether or not it is accurate. Is Julia correct to worry about receiving a large tax bill at the end of the tax year?
(b) Prepare a monthly cash budget for Julia, on the assumption that she purchases her own property, clearly setting out details of her income and expenditure and any surplus or deficit for the month. As well as the expenses listed in the case study you should include mortgage and any other relevant monthly (or one off) costs related to setting up her own home.
(c) Calculate the adjusted profit for tax purposes for Samantha’s business for 2021-22. Compute her income tax liability and National Insurance Contributions for the year (on the assumption that her only income is from the business). Explain to Samantha why she is taxed on her adjusted trading profit rather than the accounting profit. Critically evaluate the difference in tax treatment between the owner/manager of an incorporated and an unincorporated business as well as any other benefits or drawbacks to running a limited company vs being a sole trader
(d) Answer either (i) or (ii) below (but not both). Each part is worth 30 marks:
(i) Based on the research you have done to answer question (b) above, explain in detail whether in your opinion Julia can afford to buy her own home at this stage in her life. What are the various housing options open to her in the next few years, and what action does she need to take now to achieve an arrangement which suits both her aspirations and her finances? Give your reasoned recommendations.
Advise Julia on her attitude to financial and identity security.
(ii) What advice would you give to Samantha about suitable sources of finance to enable her to develop her business in the future? Explain your recommendations in detail, commenting on how different sources of finance are suitable for different kinds of expenditure. Comment on Samantha’s ideas about borrowing from family and friends.
Advise Samantha on the opportunity of taking up the suggestion of putting the £1,000 a month cash through her books.
Total: 100 marks
REMEMBER – YOU SHOULD ANSWER (d) (i) or (d) (ii) BUT NOT BOTH