CFA CFA level 3 CFA level 3 CFA level 3 CFA level 3 CFA volume 2 finquiz item set answers, study session 4, reading 10

Question ID: 11232 Correct Answer: B Maher is correct in agreeing with Hegwen’s first statement.. Maher is incorrect in agreeing with Hegwen’s second statement.. Maher is correct in di

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CFA Level III Item-set - Solution

Study Session 4 June 2018

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Reading 10: Estate Planning in a Global Context

1 Question ID: 11232

Correct Answer: B

Maher is correct in agreeing with Hegwen’s first statement Probate is the legal process to confirm the validity of the will so that executors, heirs, and other interested parties can rely on its authenticity Maher is incorrect in agreeing with Hegwen’s second statement Under community property regimes, each spouse has an indivisible one-half interest in income earned during marriage

Maher is correct in disagreeing with Hegwen’s third statement The taxation of testamentary transfers may depend upon the residency or domicile of the donor, the residency or domicile of the recipient, the tax status of the recipient, the type of asset and the location of the asset

Correct Answer: A

Since the inheritance tax rate is applied on the excess value above the threshold level, we will first calculate the value of estate subject to inheritance tax

Value of estate subject to inheritance tax = Inheritance tax/ tax rate

= 222,000/0.30

= $740,000 Now we can calculate the threshold value as:

= Total value of estate – Value of estate subject to inheritance tax

= $1,090,000 – $740,000

= $350,000

Correct Answer: C

Denilson’s first statement is incorrect Premiums paid by policy holders are typically neither part of the policy holder’s taxable estate at the time of his or her death, nor subject to a gratuitous transfer tax However, in some jurisdictions the value of the policy may attract gratuitous transfer tax

exposure to the policy holder, insured, or beneficiaries; it is important in the individual case to

determine the tax consequences of life insurance to the parties

Denilson’s second statement is also incorrect A controlled foreign company is a company located outside a taxpayer’s home country and in which the taxpayer has a controlling interest as defined by the home country law

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Probability that either James or Anie will survive for three years:

= 0.979 + 0.9987 – 0.979×0.9987

= 0.9999

Probability that either Arun or Sinhya will survive for two years:

= 0.9793 + 0.993 – 0.9793×0.993

= 0.9998

Probability that either Lionel or Mariah will survive for one year:

= 0.998 + 0.9991 – 0.998 ×0.9991

= 0.9999

First we will calculate their joint probability of survival for the next three years:

Year 1 = 0.998 + 0.9991 – 0.998×0.9991 = 0.99999

Year 2 = 0.981 + 0.9989 – 0.981 ×0.9989 = 0.999979

Year 3 = 0.979 +0.9987 – 0.979 ×0.9987 = 0.999972

We can solve for this question using a hit & trial approach

Using an expected inflation rate of 3.5% we can calculate the real-risk free rate as:

= (1+nominal risk free rate)/(1+inflation rate) – 1

= (1.055)/(1.035) – 1

= 1.932%

The capitalized value of the core spending needs is the sum of the product of the joint probability of survival and the real spending need discounted at the real risk free rate

Year Spending Joint Probability

of survival

Expected Spending Discount factor Discounted Value

1 $500,000 0.99999 $499,995 0.9810 $490,495

2 $500,000 0.999979 $499,989.5 0.96245 $481,214

3 $500,000 0.999972 $499,986 0.9442 $472,091

Total Capitalized value of core spending needs:

= $490,495 + $481,214 + $472,091

= $1,443,800

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Relative value (taxable gift) = ி௏

ி௏

= ሾଵା଴.ଵଶሺଵି଴.ଷ଴ሻሿ [ଵା଴.ଵଶሺଵି଴.ସ଴ሻ]

= 1.0931

The formula to calculate the future value of a tax-free gift is:

FVGIFT = [1 + rg (1 – tig)]n

= £312,000[1 + 0.05(1 – 0.22)]7

= £407,815.22 ≈ £407,815

The taxable value of the gift is currently worth £388,000 [(£2,000,000 × 0.35) – £312,000]

The formula to calculate the future value of the taxable transfer/gift is:

FVGIFT = [1 + rg(1 – tig)]n(1 – Tg)

= £388,000 × [1 + 0.05(1 – 0.22)]7(1 – 0.25)

= £380,366 ≈ £380,000

The formula to calculate relative after-tax value of a gift where the donor pays the transfer tax is as follows:

RVTaxableGift= FVGift

FVBequest =   1 + rg( 1 − tig)  n

1 − Tg+ TgTe

1 + re( 1 − tie)

1 − Te

RV TaxableGift = [ ( ) ] [ ( ) ]

40 0 25 0 25 0 1 22 0 1 05 0 1

7 7

−

− +

× +

−

− +

76336756

0

11103505

1

≈

=

The probability of survival is calculated is as follows:

p (Survival) = p (Husband survives) + p (Wife survives) – p (Husband survives) × p (Wife survives)

p (Survival2nd Year) = 0.7035 + 0.8455 – (0.7035 × 0.8455)

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The capitalized value of the couple’s core spending needs is calculating by multiplying each year’s annual spending amount by the corresponding joint survival probability This yields the couple’s expected spending amount for each year The annual expected spending amount is in turn discounted

at the real risk-free rate, 4.5% (8.0% − 3.5%)

Year Annual

Spending

Joint Survival Probability

Expected Spending

Discounted Value

1 65,000 0.9695 63,014.42 60,300.88

2 65,000 0.9542 62,022.40 56,795.77

3 65,000 0.9182 59,682.02 52,299.15

4 65,000 0.8437 54,840.65 45,987.25

PV (Spending need) = ( )

( )

∑

×

N

j

j j

r

Spending Survival

p

The capitalized value of their core spending needs is thus the sum of the discounted values, i.e

£215,383.04 or £215,383

The applicable tax rate under the deduction method is calculated as follows:

TDeductionMethod = TResidence + T Source − TResidenceTSource

= 30% + 40% − (30% × 40%)

= 58%

Thus the applicable investment tax rate is 58% out of which 40% will be remitted to Kenya and the remainder 18% (58% − 40%) to U.K

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