8 Tax Allowance in Unit Pricing

Question 1

Define the appropriation price in unit pricing. (2)

Answer 1

The amount of money per unit put into a unit linked fund for each new unit created, such that the net asset value per unit is the same after as before the appropriation.

Question 2

Define the expropriation price in unit pricing. (2)

Answer 2

The price at which units are cancelled. The amount of money to be taken out of the fund in respect of each unit in order to preserve the interests of continuing policyholders.

Question 3

What is meant by ‘offer basis’ in the context of unit pricing? (2)

Answer 3

Units will be priced on an offer basis whenever the transaction involves the creation of units. The amount of money put into the fund would be the number of units times the appropriation price.

Question 4

What is meant by ‘bid basis’ in the context of unit pricing? (2)

Answer 4

Units are priced on a bid basis whenever a transaction involves the cancellation of units. The amount of money removed from the fund is equal to the number of units cancelled times the expropriation price.

Question 5

Define ‘offer price’ in unit pricing. (1)

Answer 5

The price used to allocate units to a unitised contract.

Question 6

Define ‘bid price’ in unit pricing. (1)

Answer 6

The price used to redeem units that have been allocated to a unitised contract.

Question 7

Describe the tax treatment of unrealised gains when pricing on an offer basis. (4)

Answer 7

Provision should be made for the tax on accrued chargeable gains using the full tax rate, discounted to allow for the period to the expected date of realisation.

As indexation relief will be available on future gains, the discount rate is the net real rate of return expected on the funds assets.

The estimates should be as realistic as possible to minimise gains or losses to policyholders due to actual experience being different from expected.

Question 8

Describe the tax treatment of unrealised gains when pricing on a bid basis. (3)

Answer 8

Provision should be made for the tax on accrued chargeable gains using the full tax rate.

There may less (or no) discounting applied than when pricing on an offer basis for a contracting fund as the tax liability will crystallise immediately.

The estimates should be as realistic as possible to minimise gains or losses to policyholders due to actual experience being different from expected.

Question 9

Describe the tax treatment of unrealised losses when pricing on an offer basis. (4)

Answer 9

Accrued unrealised losses should be treated in the same way as gains, in that losses can be regards negative gains.

If it is assumed that all assets will be showing gains, after indexation, by the time they are sold, the position is no different from accrued gains.

But if it is assumed losses will be realised, where no tax is immediately recoverable, the tax asset recoverable on future gains should be discounted from the expected date of recovery at the net nominal rate of return expected on the fund’s assets.

(Nominal rate because indexation cannot be used to enhance any loss).

Question 10

Describe the tax treatment of unrealised losses when pricing on a bid basis. (3)

Answer 10

Pricing on a bid basis assumes that assets are being sold and units cancelled. Losses will be realised sooner than in an expanding fund.

An addition to the unit price in respect of the losses can be given only if chargeable gains are expected in the future against which the losses can be offset.

Question 11

What is the basic equity principle of unit pricing for an internal unit find? (1)

Answer 11

The interests of unit holders not involved in a unit transaction should be unaffected by that transaction.