AF4: Indirect investments

Question 1

State 5 key ways that an investment trust differs from an OEIC or unit trust?

www.pstgroup.co.uk

Answer 1

1. With an OEIC/UT: price x number of units/shares = fund assets. The value of an investment trust will rarely match the value of the assets and will usually trade at a discount or a premium.
2. An investment trust is a share in a company that exists to make investments; its share with be subject to market fluctuations like any other.
3. An invstment trust can borrow to invest i.e.called gearing. OEICs and UTs have limited powers to borrow.
4. Unit trusts and OEICs are generally limited to holding no more than 10% of the fund assets in the shares of a single company. An investment trust has no such restrictions.
5. An investment trust is a closed-ended fund; an OEIC/UT is open-ended.

Question 2

What is a REIT (Real Estate Investment Trust) and how is it structured?

Answer 2

A REIT is a closed-ended investment trust. It allows investors to invest in property by buying shares in the investment trust.

A REIT has a two-part structure:

1. a ring-fenced property letting business - which is exempt from corporation tax, and
2. a non ring-fenced businesss - which might include things like property management. Profits from this are subject to corporation tax.

Question 3

What are the HMRC rules that need to be satisfied to become a REIT?

Answer 3

1. At least 75% of the assets must be in property
2. At least 75% of the profit made must come from property letting (ring-fenced element)
3. 90% of the ring fenced profits must be distributed within 12 months of the end of the accounting period
4. Any interest costs on borowing must be covered by 125% of rental profits
5. A minimum of 3 properties in the fund
6. No single property exceeds 40% of the value of the fund

Question 4

James has a shareholding in a REIT. How will his income and gains be taxed?

Answer 4

Ring-fenced element

Income is paid net of 20% tax (still!). Higher/additional rate taxpayers will pay extra tax through self-assessment. Holdings in ISAs are tax-free and non-taxpayers can reclaim the 20%.

Non-ring-fenced element

Income is treated as ‘dividends’ and taxed in the same way.

For CGT, both elemnts are subject to normal rules, e.g. annual exemption, chargeable gains taxed at 10% or 20%.

Question 5

What are the main differences between a reporting and non reporting offshore fund?

Answer 5

Reporting funds is where all income is declared to HMRC and the investor is taxed as income arises. They are taxed like UK dividends or interest for UK investor. CGT exemption can be used on any gains.
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Non-reporting funds is where no income is distributed and is ‘rolled up’. On encashment, any gain is calculated using CGT principles but taxed as income at 20%, 40% or 45%. No CGT exemption can be used.

Question 6

How are structured products designed?

Answer 6

For the capital protected element, cash or discounted bond is used.

For the gain prospects, a derrivative is used which is often an option.