ACCA Advanced Financial Management (AFM) Practice Exam

Which of the following is an advantage of capital gains taxation?

1. Immediate taxation upon investment

2. Ability to avoid taxes on inherited shares

3. Tax is always paid annually

4. Tax is applied to dividends only

The correct answer is: Ability to avoid taxes on inherited shares

The advantage of capital gains taxation being the ability to avoid taxes on inherited shares is rooted in the way tax liabilities are structured in relation to inherited assets. When assets such as shares are inherited, the beneficiary typically receives a "stepped-up" basis, meaning that the cost basis of the asset is adjusted to its fair market value at the date of the decedent's death. As a result, if the heir later sells the shares, they only pay capital gains tax on any increase in value from that point forward, effectively avoiding any tax on gains that accrued during the original owner's period of ownership. This can provide significant tax efficiency and relief for beneficiaries. In contrast, immediate taxation upon investment refers to taxes that are levied upfront, which is not characteristic of capital gains taxation. Capital gains taxes are typically realized on profit when the asset is sold, not at the point of investment. The notion that tax is always paid annually does not accurately reflect capital gains taxation, as it is typically incurred only upon the realization of gains through a sale event. Furthermore, capital gains tax applies to profits made from the sale of assets, not specifically to dividends, which are subject to different taxation altogether. Focusing on the inherited share option highlights the unique advantages of capital