ACCA Taxation (F6) Practice Exam

How is the base cost for the donee calculated in a sale at undervalue scenario?

1. Original cost of the asset

2. Market value plus any gains realized

3. Market value minus the gain deferred

4. Market value only

The correct answer is: Market value minus the gain deferred

In a sale at undervalue scenario, particularly concerning gifts or transfers between connected individuals, determining the base cost for the donee involves considering how unrealized gains are treated. The correct approach is to use the market value of the asset at the time of transfer, but any gains associated with the asset that are not immediately realized by the recipient are deferred. When the donee acquires the asset below its market value, the base cost is effectively calculated as the market value of the asset minus any gains that are deferred. This adjustment reflects the reality that while the donee receives the asset for a lower price, the unrecognized gain will need to be accounted for when the donee ultimately disposes of the asset. Such treatment ensures that when the asset is eventually sold, any liability for capital gains tax takes into consideration the original value that would have been attributed if it had been valued at market rates. This method prevents the donee from receiving a tax advantage simply due to the undervalued transfer while maintaining fidelity to the economic reality of the transaction. The original cost of the asset or just the market value would not accurately reflect the tax implications and the potential deferred gains scenario inherent in such transfers.