10 - Indirect Investments Flashcards
Three main stages to consider regarding tax wrappers
- How the initial investment is treated
- How the funds are taxed within the wrapper
- How the proceeds are taxed on the investor
Pensions
What are the tax benefits of pensions?
- Tax relief on contributions;
- No tax on gains or investment income within the fund;
- 25% tax free on crystallisation;
- Tax free death benefits before age 75.
Note that other than the tax free lump sum other benefits paid are subject to tax, so pensions don’t offer complete tax protection.
Pensions
How much contribution can you make to your pension?
The usual annual allowance is £40k.
If your relevant earnings are lower you will only be able to contribute that much, although everybody can contribute £3,600 (with basic tax relief).
If you earn over £150k your annual allowance reduces by £1 for every £2 above £150k, down to a £10k minimum.
Also note that unused annual allowances from the last 3 years (so 16/17, 15/16 and 14/15) could be carried forward into this year (17/18).
Pensions
What are the methods of making pension contributions and getting tax relief on them?
- Net Pay Method - Contributions taken out of your pay by your employer before you get taxed, so you never pay the tax.
- Relief at Source - You pay the contribution yourself and get basic rate tax relief straight away (eg you contribute £10k and the pension scheme credits you with £12.5k). Higher/additional rate payers then re-claim extra tax relief via self assessment (on the gross contribution, i.e. £12.5k).
Pensions
Any restricted asset classes?
Borrowing limits?
Residential property and moveable tangible assets will trigger a tax charge.
50% of net fund value is allowed as borrowing.
ISA
Who is eligible to invest?
UK residents
ISA
Age limits for various types
Stocks and shares, IFISA, Lifetime ISA: 18 years
Cash: 16 years
Under 18’s who aren’t entitled to child trust funds can get junior ISAs
[This means born after 2/1/11 or before 1/9/02]
ISA
What are the annual investment limits?
£20k across all classes of ISA
Except junior ISA which is £4,128
and Lifetime ISA which is £4k
ISA
Transfer rules
Marriage death rule
You can transfer between all types of ISA and transfer previous years ISAs without affecting your current year allowance.
You can also withdraw cash from an ISA during a year and replace it later in the same year without using up your allowance.
On death your spouse gets an extended allowance of ISA contributions equal to the amount of ISAs you had on death (so they can effectively keep your ISA investments inside the ISA wrapper under their own name).
ISA
What are the tax benefits of ISAs?
No tax benefits on contributions (unlike pensions) but funds within the wrapper are tax free (no CGT, investment income tax, savings tax etc.).
When you withdraw the cash at the end you won’t have to pay tax, but you didn’t receive a tax benefit on the contribution so this is to be expected.
Child Trust Funds
Who can have them?
Maximum contributions
Vouchers from government
Available to children born between 31/8/02 and 1/1/11.
Maximum contributions are £4,128 pa up to age 18.
The initial voucher offered by the government was £250, but reduced to £50 from 31/7/10.
Child Trust Fund
Investment types
- Savings accounts;
- Accounts investing in shares;
- Stakeholder accounts (1.5% fee limit, equity investment till age 13 then moves towards cash).
Child Trust Fund
Tax treatment
Same as ISAs, funds invested are free from tax on gains and investment/savings income.
Also CTFs are exempt from the rule of taxing parents on investment income in excess of £100.
UK Collectives
Treatment of divs and interest
Gains treatment
Dividends and interest are paid gross (taxable on investor of course).
Gains are also subject to CGT (and losses allowable).
Offshore Collectives
What are the two types of fund and the major differences?
- Reporting funds: These have had reported status granted by HMRC. They report the investors share of the income each year (don’t need to distribute it) so the investor can put it in self assessment and pay tax. Liable to CGT at maturity (only on the gains).
- Non-reporting funds: Any offshore funds that aren’t given reported status. All income and gains are wrapped up and paid over at the end. Then tax is calculated based on CGT principles but taxed as income, not CGT (so proceeds less original cost less any costs incurred).
Offshore Collectives
What are the advantages of reporting funds?
- Can use dividend allowance, get normal dividend tax rates on income throughout the life.
- CGT rates on gains at enchashment.
- Use of annual exemption for CGT at maturity.
Offshore Collectives
What are the advantages of non-reporting funds?
- Get taxed later in life when you might be in a lower income tax band.
- Income accumulated in a low tax environment.
- Non-UK residents don’t pay any tax.
- Non-UK domiciles don’t pay tax as nothing is remitted.
- No IHT for non-UK domiciles as this is excluded property.
Offshore Collectives
Tax treatment of dividends and interest within the funds
Dividends within the funds are usually subject to withholding tax, which is not reclaimable.
Most bonds (eg eurobonds, exempt gilts) pay income gross.
Life Assurance
What are qualifying and non-qualifying policies?
- Qualifying policies: Life policies with regular level premiums, payable at least annually for at least 10 years, maximum £3,600 annual premium.
- Non-qualifying policies: Single premium life policies.
Life Assurance
How are life companies taxed?
Taxes payable by the life company are not recoverable by policy holders.
- Dividends are tax free;
- Rentals, interest, offshore income all taxed at 20%;
- Capital gains taxed at 20%.
Life Assurance
How are policy holders taxed?
You are charged income tax on profits on the policy.
Gains are referred to as chargeable gains, but they are not subject to CGT.
Qualifying policies however will only pay tax within the first 10 years, if they reach 10 year life they are entirely tax free.
Life Assurance
What are the key chargeable and non-chargeable events?
Chargeable events
- Death;
- Maturity;
- Assignment (sale);
- Surrender (sometimes part surrender also);
- Policy loan.
Non-Chargeable events
- Assignment by way of mortgage;
- Assignment between spouses;
- Payment of critical illness.
Life Assurance
How is the chargeable gain calculated?
- Maturity/Surrender: Amount paid out less premiums paid.
- Death: Surrender value before death less premiums paid.
- Assignment: Price received less premiums paid (unless assignment between connected persons, then market value instead of price received).
Life Assurance
How do partial surrenders work?
Part surrenders of up to 5% per annum (of your original investment) can be withdrawn with no tax charge (i.e. not a chargeable event).
The 5% can be rolled forwards if not used.
If over 5% is withdrawn it is a chargeable event and the excess is a chargeable gain.
Otherwise the only tax is payable at maturity, when the partial surrenders will form part of the total gains on the policy.
Life Assurance
How are the gains on a policy calculated at termination?
Paid as income at income tax rates, less basic rate tax (so 0%, 20%, 25% effectively).
Use top-slicing to ensure that you don’t get screwed if the gain takes you into the next tax band.
- Divide gain by number of years of the policy;
- Calculate income tax with and without that amount added to income;
- Take the difference between those two outcomes and deduct 20% of the gain (since you don’t pay basic rate tax);
- Multiply that result by the number of years of the policy.
Life Assurance
What effect does it have if the life assurance bond is segmented into several individual policies?
Each individual policy is a separate investment for tax purposes.
Life Assurance
How are jointly held policies treated?
Considerations for married couples
Jointly held policies just split between the two holders for tax purposes.
Spouses should consider transferring between themselves (which is a non-chargeable event) before gains are due to optimise tax (eg transfer to the spouse in the lower tax band).
Life Assurance
How is tax administered?
The life office issues a certificate to the policyholder on a chargeable event.
Policyholder must then provide the details in self assessment.
Life Policies
What are friendly society policies?
These are qualifying policies that are tax free with limited premiums.
£270pa or £25pm limit to premiums.
Under 18s versions called baby bonds.
Annuities
How are annuities taxed in general?
A “purchased annuities certain” (i.e. fixed term annuity) gets taxed as savings income, except the capital content is tax free.
E.g. if you spend £100 on a five year annuity you might get £25 return every year. Taxing £25 income and claiming a £100 capital loss at maturity wouldn’t make sense. Instead £20 income is considered capital return and you are taxed on £5 savings income each year.
A purchase life annuity works similarly, except the capital content is based on HMRC mortality tables (divide initial investment by your life expectancy per the mortality tables to get the capital content of each payment).
Annuities
Impact if purchased annuity certain is paid to somebody other than the payer of the premium
Tax on annuities for beneficiaries (eg will or trust)
If the annuity payment on fixed term annuity is paid to a third party then the capital content is no longer tax free.
For annuities paid to a beneficiary (under a will or trust) basic tax is deducted at source and all income is taxed as investment income.
Annuities
How are pension annuities taxed?
Like other pension income, it is taxed in full as income tax.
Annuities
Any tax-free annuities or annuity related payments?
- Cash sum payable under guaranteed annuity is tax free;
- Structured settlements - annuity paid in settlement of a claim for damages, tax free at source and in the hands of the recipient;
- Immediate needs annuity - tax free if used for long-term care and paid directly to the care provider.
Annuities
Requirement for annuities to be paid gross
Need to complete R89 form if the total income is below your personal allowance.
Offshore Life Assurance
Tax treatment of offshore life assurance
Similar to offshore bonds.
Get rolled up gross (no tax charge until the end) although there may be withholding taxes (not reclaimable).
Liable to income tax at your highest rate on the final gain.
You get relief on the tax relating to periods of non-UK residency, although you would also lose that number of years of top slicing.
Note that offshore life policies are all non-qualifying after 1983.
Offshore Life Assurance
Summary of tax differences between UK and offshore life assurance
UK life assurance policies get basic rate tax relief, so higher and additional rate taxpayers pay 20% and 25%.
Offshore would pay full 40% and 45%.
Also holders of an offshore policy who were non-resident for part of the life only get taxed on the gains for the years in which they were in the UK (top-slicing years also reduced accordingly).
Offshore Life Assurance
How is tax administered?
Offshore life office must have a “tax representative” who is responsible for issuing chargeable gain certificates.
What do you need to know about personal portfolio bonds?
They are taxed heavily since HMRC deems them to be a tax avoidance vehicle.
Charged as if they yielded 15% compound.
What advice might you give to ex-pats relating to offshore investments if they are coming back to live in the UK?
They should consider encashing investments before they become resident in UK again to avoid paying UK tax on the whole gains.
Overseas Life Assurance Business
What is this and how is it taxed?
This is life assurance provided by UK life offices for non-UK residents.
Policy holders aren’t taxed on income or gains within OLAB funds.
If an OLAB fund becomes non-qualifying it will be treated like an offshore life assurance policy.
Property
What are the requirements for a REIT?
- UK tax resident;
- Closed ended company;
- Listed on recognised stock exchange (including AIM);
- At least 75% of profits from lettings (in order to qualify for corporation tax exemption);
- Interest on borrowing must be covered 125% by rental profits;
- Gains from property development taxed (unless held for at least 3 years after completion);
- At least 90% of rental income paid out as dividends.
Property
Taxation of REIT distributions
- Tax exempt element - classed as property income, distributed net of 20% tax;
- Non-tax exempt - these are just normal dividends, paid gross;
- Gains on REITs taxed in normal way as CGT.
Property
Features of Insurance Company Property Funds
- Value of units linked directly to the underlying properties;
- No gearing;
- Have higher liquidity than direct property investments, but varying notice periods.
Property
Notes on other property funds (unit trusts, OEICS, investment companies)
- FCA authorised property funds can be held within ISAs;
- More tax efficient than life assurance property funds.
EIS
Benefits of EIS investments
- Tax relief of 30% on invested amount, up to £1m of investments pa;
- Tax relief can be carried back to the prior tax year;
- Disposals CGT exempt (if held for 3 years);
- CGT Deferral - If you reinvest a gain into EIS shares you can defer CGT on the gain until you sell the EIS shares. Gives maximum 58% relief (30% income tax relief plus 28% CGT deferral).
EIS
Requirements for investment to qualify for EIS (5)
- Investor needs to be liable to UK income tax (not necessarily UK resident);
- Investor can’t be connected to the company (eg an employee);
- No pre-arranged exit strategy;
- Must hold the shares for 3 years;
- Company must meet qualifying rules (and keep meeting them).
EIS
Qualifying rules for the company
- Gross assets up to £15m before raise (£16m after);
- Qualifying trade (see list of non-qualifying trades);
- Permanent establishment in UK (don’t need to trade in the UK or bwe resident in the UK);
- Unlisted when the shares are issued;
- Fewer than 250 employees;
- No more than £5m raised under EIS.
EIS
What are the non-qualifying trades?
- Dealing in land, commodities, futures, shares or securities;
- Banking and insurance;
- Property development;
- Legal or accountancy services;
- Forestry and timber production;
- Companies benefitting from Renewables Obligation Certificates (ROC) or the Renewable Heat Incentive (RHI).
SEIS
Relief and requirements
- Get 50% income tax relief up to £100k max investment per year;
- Also get CGT deferral but only on up to half of your gain on the old investment can be deferred;
- Need to have been trading for less than 2 years
- Need gross assets below £200k;
- Fewer than 25 employees.
VCT
Tax benefits
Holding requirement
- 30% income tax relief on investments up to £200k per year;
- Up to £200k dividends from VCTs tax free per year (note that EIS/SEIS dividends fully taxable);
- CGT exempt on disposal (no CGT deferral unlike EIS/SEIS).
Holding requirement: Shares must be held for 5 years
VCT
Qualifying conditions for the trust
- Not a close company;
- Listed on a stock exchange;
- Income derrived wholly/mainly from shares or securities;
- 70% of investment by value in qualifying unlisted trading companies;
- No more than 15% in any one company;
- At least 10% of each qualifying holding in new ordinary shares;
- At least 70% of investments by value in qualifying holdings must be in new ordinary shares.
VCT
Qualifying conditions for companies invested in
- Less than 250 emplyees;
- Less than £15m gross assets before and £16m after investment;
- Up to £5m invested annually in one company.
What are the new rules from late 2015 regarding EIS/SEIS/VCTs?
- Can’t invest in companies over 7 years since their first commercial sale (10 years for Knowledge Intensive Firms (KIFs)), unless the investment is at least 50% of average turnover over last 5 years;
- Cap on investment into any single firm (across EIS, SEIS, VCT) of £12m (£20m for KIFs);
- KIFs employee limit 500 (up from 250);
- EISs and VCTs disallowed from funding buy-outs, including management buy-outs of VCT funds raised pre 2012 and VCT non-qualifying holdings.
Structured Products
Tax treatment
IHT note
Can distribute income, give gains or roll up income. Charged income tax on income (even if rolled up to maturity), otherwise CGT.
If held in ISA or pension there’s no tax (as expected).
Can be used to reduce IHT value, since the value in the middle of the life is often discounted compared to what they’re worth (and what you’ll get at maturity).
Social Enterprises
How do they work?
Very similar to EIS, 30% tax relief on up to £1m of investment each year (can be carried back to last tax year), no CGT on disposal, CGT deferral available.
Also the company must have gross assets below £15m and fewer than 250 employees.
However the investment can be in debt or equities (EIS/SEIS is equity only) and the company must have a defined and regulated social purpose.
What is the difference between offshore funds and offshore bonds?
Offshore funds are investment funds (like OEICs) which are either reporting or non-reporting. Reporting funds are just like normal OEICs (income tax on divs, CGT on gains), non-reporting have all gains rolled up to maturity then charged in one shot as income tax.
Offshore bonds are life assurance investments. Like onshore life assurance bonds you get top-slicing. But your gain is only taxed based on the number of years you were resident in the UK (number of top-slicing years also reduced on this basis).
