Chapter 10 - Indirect Investments

Question 1

Individual Savings Account (ISA)

Answer 1

• Income and capital gains free of tax (no need to declare on tax return)
• Encashment free of income tax and CGT
• Advantage more pronounced on income producing funds for higher/additional rate taxpayers
• Tax privileged open-ended plans with tax year-based investment limits
• Types
  o Cash 16+
  o Stocks & Shares 18+– including collectives
  o Innovative finance 18+ – peer to peer loans and crowd bonds
  o Help to Buy ISA – existing customers only
  o Lifetime ISA – age 18-39 at outset, £4,000 limit, first home / retirement o Junior ISA – cash, stocks and shares
• Eligibility - UK Resident (or a non-resident Crown employee working overseas and subject to UK tax on earnings - but not their spouse)
• Individual basis
• Can invest in Cash ISA, IFISA and Stocks and Shares ISA during tax year/subject to overall limit of £20,000. Up to £4,000 of £20,000 limit can go into Lifetime ISA.
• Can withdraw cash from ISA and replace in the same tax year without it counting towards subscription limit (if provider allows flexibility)
• Can only invest with one provider at a time for each type of ISA during the tax year
• Junior ISA - available for children born after 02/01/11 - annual limit is £9,000 (2021/22)

Question 2

ISA Transfers

ISAs on death

Answer 2

ISA Transfers

• Can now transfer between all types of ISAs
• Can transfer previous years ISA without affecting current year’s allowance

ISAs on death
- On death, ISA becomes continuing ISA of deceased
o No further funds added
o Income/gains tax free until earlier of estate being administered, continuing ISA being closed or 3 years and one day from death
- If an ISA holder in a marriage or civil partnership dies
o ISA benefits can be passed to spouse/civil partner via an additional ISA allowance.
o The surviving spouse/civil partner can invest as much as their spouse/partner used to have, in addition to their own annual ISA limit
- The actual amount is the higher of the value of the continuing ISA on death or on the date when the ISA wrapped investments were passed on

Question 3

Child Trust Funds (CTF)

Answer 3

• Children born 31/08/02 - 01/01/11 entitled to CTF
• Initial voucher £250 (£50 from 31/07/10)
• Further £9,000 contributions per annum permitted till age 18 (cannot carry forward)
• Children born after 02/01/11 not entitled to CTF
• First CTFs matured in Sept 2020 – can roll into adult ISA without affecting subscription limit

CTF and Tax

• Free on income tax and CGT
• Exempt from rule of taxing parent on investment income in excess of £100

Planning issues re JISA / CTF

• Compare charges / returns / interest rates
• Money is usually locked in until 18, then belongs to child to do with as they wish
• If parents want control of funds, need to use a different investment / trust wrapper

Question 4

UK Collectives

Answer 4

• Investment trusts, unit trusts and Open-Ended Investment Companies (OEICs)
• Allows participation in large portfolio of shares with other investors
• Purchase units in unit trust and shares in OEIC
• Different types of funds
• Unit trusts and OEICs are open ended (investment trusts are closed ended)
• Charges - normally initial charge and AMC
• Dividends paid gross, after dividend allowance, taxed at 7.5%, 32.5%, 38.1%
• Interest distributions paid gross, after personal savings allowance, taxed at 20%, 40% and 45%
• Gains on disposal liable for CGT (losses allowable) after annual exempt amount, taxed at 10% and 20%

Question 5

Offshore Collectives

Answer 5

• Offshore funds generally set up in countries with little/no local taxation e.g., Channel Islands
• IHT planning – excluded property for non-UK doms

Question 6

Non-Reporting Funds

Answer 6

• Any fund that hasn’t obtained reporting fund status
• Income normally accumulated/no tax on income as it arises
• Gains on disposal (including death) calculated on CGT principles
• Taxed in year of encashment
• Any accumulated income makes up part of the gain
• However liable to income tax (so cannot use CGT annual exempt amount)
• Planning – those who pay tax at higher rates can delay encashment until non or basic rate taxpayer or non-resident

Question 7

Reporting Fund Advantages & Non-Reporting Fund Advantages

Answer 7

Reporting Fund Advantages

• Normal rates of tax on dividends/can use dividend allowance
• CGT rates on encashment
• Use of annual exempt amount

Non-Reporting Fund Advantages

• Accumulate income in low tax environment
• Roll up income/take profit when lower taxpayer
• If non-UK resident income/gains are tax free
• Non-UK-domicile - income and gains not remitted to UK so no UK tax liability
• Excluded property for non-UK- domiciles so no IHT

Question 8

Offshore Funds and Tax

Answer 8

• Offshore equity funds - dividends normally subject to withholding tax (non- reclaimable)
• Fixed interest - Eurobonds and exempt gilts pay income gross

Question 9

Special Purpose Vehicles

Answer 9

• Usually limited partnership or exempt UK unit trust/investment trust set up to finance specific projects
• Allows investments to be made from SIPP, SSAS and registered charities
• Income used to service debt so only offer capital growth

Question 10

Shares in Listed Property Companies

Answer 10

• More liquid than investing directly in property
• Investment is diversified over a number of properties
• Property shares move more rapidly than property market

Question 11

Real Estate Investment Trusts (REITs)

Conditions

REIT Distributions

Answer 11

Real Estate Investment Trusts (REITs)
- Investment companies that enable investors to put money into residential and commercial property markets by investing in them

Conditions

• Must be UK tax resident
• Closed ended company
• Listed on recognised stock exchange (including AIM)
• At least 75% of company’ s gross profits have to originate from property letting (to qualify for exemption from corporation tax)
• Interest on borrowing must be 125% covered by rental profits
• Gains from property development taxed unless held for 3 years from completion
• At least 90% of rental profits must be paid out as dividends

REIT Distributions

• Tax exempt element - classed as property income and taxed at 20%
• Non-exempt element - dividend payment paid gross
• REIT gains subject to CGT in normal way

Question 12

Insurance Company Property Funds

Answer 12

• Value of units linked directly to underlying properties
• No gearing
• Higher liquidity than direct property investment, but notice periods can apply

Question 13

Property Unit Trusts, OEICs and Investment Companies

Answer 13

• FCA authorised property funds permitted within ISAs
• Similar to life assurance property funds but more tax efficient
• Property security funds; invest in property companies and REITs (UK and overseas)

Question 14

Enterprise Investment Scheme (EIS)

Answer 14

• 30% tax relief on qualifying investments up to £1m in a tax year (£2m providing amount in excess of £1m invested in knowledge-intensive companies)
• Disposals exempt from CGT if held for 3 years
• Investors cannot be connected with company when subscribing
• Investors need not be UK resident (but must be liable to UK income tax)
• No pre-arranged exit strategy
• Qualifying companies:
  o Gross assets not exceeding £15m prior to investment (£16m after)
  o Qualifying trade
  o Permanent establishment in UK although no need to trade in or be resident in UK
  o Unlisted when EIS shares issued
  o Fewer than 250 full time employees (500 for knowledge-intensive firms)
  o No more than £5m raised under EIS (£10m for knowledge-intensive firms)
• Excluded qualifying trades include:
  o Dealing in land, commodities, futures, shares or securities
  o Banking and insurance
  o Property development
  o Legal or accountancy services
  o Forestry and timber production
  o Companies benefiting from renewables obligation certificates (ROCs)
  o and/or the renewable heat incentive (RHI)
• Withdrawal of relief:
  o If shares disposed of within 3 years
  o If company ceases to be qualifying
• CGT deferral
  o Defer CGT by reinvesting gain into shares that qualify under EIS
  o Maximum potential tax relief 58% (30% income tax and up to 28% CGT)
• Tax planning
  o High risk, illiquid
  o Can offset losses against income tax or CGT

Question 15

Seed Enterprise Investment Scheme

Answer 15

• Runs alongside EIS but targeting smaller start-ups
• Income tax relief at 50% of up to £100,000.
• Trading for less than 2 years with gross assets of less than £200,000
• Fewer than 25 full time employees
• Exemption from CGT limited to one half of investment
• Maximum tax relief is 64% (50% income tax and 28% CGT exemption on 50% of a reinvested gain)

Question 16

Venture Capital Trusts (VCTs)

Answer 16

• Must invest in unlisted trading companies
• 30% income tax relief on investments up to £200,000 per tax year
• Dividends from VCTs up to £200,000 per tax year are tax free
• CGT exempt on disposal of VCT shares but cannot use to defer CGT gains
• Income tax relief withdrawn if shares disposed of within 5 years
• Risk spread somewhat as invest in range of small companies, but still high risk and illiquid as an investment
• Qualifying companies
  o Not a close company
  o Must be listed on stock exchange
  o Income derived wholly/mainly from shares or securities
  o 80% of investment by value in qualifying unlisted trading companies
  o No more than 15% in one company
  o At least 10% of qualifying holdings in new ordinary shares
  o At least 70% of investments by value in qualifying holdings must be in new
  ordinary shares
• Qualifying conditions:
  o Less than 250 employees (500 for knowledge-intensive firms)
  o Less than £15m of gross assets before investment and £16m after investment
  o Annual amount which may be invested in one company is £5m (£10m for knowledge-intensive firms)

-New rules which affect EIS, SEIS and VCTs came into effect late 2015:
o Investors not permitted to invest in firms over 7 years or more after their first commercial sale took place (10 years + for knowledge intensive firms (KIFs)) unless the investment represents more than 50% average turnover for previous 5 years

• KIFs can chose whether to use current test of date of first commercial sale or point at which turnover reached £200k to determine when 10-year period (EIS) / 7-year period (VCT) began
  o Cap on investment into a firm from EISs/SEISs and VCTs of £12m (£20m KIFs)
  o EISs and VCTs not able to fund buyouts including management buy-outs to VCT funds raised prior to 2012 and VCT non-qualifying holdings

Question 17

Social enterprises

Answer 17

• Social investment tax relief (SITR)
• Similar to EIS
• 30% income tax relief on investment up to £1,000,000 per tax year
• Can be carried back to previous tax year
• Investment can be in debt or equities
• CGT deferral available
• Disposal exempt from CGT
• Eligible organisations must have a defined and regulated social purpose, have fewer than 250 employees and gross assets of no more than £15m

Question 18

UK Life Assurance Policies

Answer 18

• Qualifying life policies - life policies with regular level premiums payable at least annually for at least 10 years/£3,600 annual premium limit
• Non-qualifying policies - single premium investments

Question 19

UK Life Assurance Policies - Taxation

Life Company Taxation

Policyholder Taxation

Answer 19

• Qualifying policies are more favourable as only gains within first 10 years are taxable
• All gains from non-qualifying policies are taxable

Life Company Taxation

• No tax on dividend income
• 20% tax on rental, interest, offshore income
• Gains taxed at 20% (indexation relief up to December 2017 only)
• Paid by life office
• Cannot be reclaimed by policyholder, therefore less tax-efficient for many than collectives (especially non taxpayers)

Policyholder Taxation

• Income tax on policy profits
• Gains referred to as chargeable gains
• But not subject to CGT

Question 20

UK Life Assurance Policies -

Chargeable Events

Non-Chargeable Events

Calculating Chargeable Gain

Answer 20

Chargeable Events on non qualifying policies
 Death (if gives rise to a benefit)
 Maturity
 Surrender and certain part surrenders
 Assignment for money’s worth
 Policy loan (if taken out after 26/03/74)

Non-Chargeable Events
 Assignment by way of mortgage
 Assignment between spouses (could be useful where one is a higher / additional rate taxpayer and the other isn’t – assign and then surrender
 Payment of critical illness
 If the policy was issued before 26 June 1982

Calculating Chargeable Gain
 Maturity/Surrender
o Amount paid out (including any capital payments) less premiums paid (including
any previous chargeable gains)
 Death
o Surrender value before death (plus any capital payments) less premiums paid (including any previous chargeable events)
 Assignment
o Price received (plus capital payments) less premiums paid (including previous
chargeable gains)
 If assignment is between connected persons, then market value used

Question 21

UK Life Assurance Policies -

Part Surrenders

Tax on Part Surrenders

Answer 21

Part Surrenders
 Includes bonus encashment or loans
 Chargeable if exceed certain limit
 Total part surrenders considered per policy loan (not individual part surrenders)
 Chargeable event only if reckonable aggregate value exceeds allowable aggregate value
 5% withdrawal allowed without chargeable event
 Able to carry forward unused 5% allowance
 Any 5% taken brought back into calculation on final encashment
 Allows higher and additional rate taxpayers regular ‘income’ without immediate charge to tax, even more tax efficient if basic rate taxpayer on final encashment
 Adviser charging is part 5% allowance

Tax on Part Surrenders
 If surrenders exceed allowance, then chargeable event and excess is chargeable gain
 Occurs at end of policy year
 Individual owning policy at time of chargeable event is liable
 If tax charge excessive, can approach HMRC

Question 22

UK Life Assurance Policies -

Taxation of Gain - 5-step process

Answer 22

Taxation of Gain
 Falls fully in basic rate – no tax due
 Falls fully in higher- 20% of gain, though may be reduced by PSA
 Falls fully in additional – 25% of gain
 If straddles tax band, use top-slicing relief to spread gain over policy years using 5 - step process
 5-step process

Step 1: Calculate investor’s taxable income (to establish how much of gain falls into starting rate, personal savings allowance, basic rate, higher rate, additional rate) – ignore gift aid donations

Step 2: Calculate tax due on gain across each tax band and deduct 20% basic rate tax to show total liability

Step 3: Calculate annual equivalent of gain which is the gain divided by N, where N is:
o Onshore policies, full surrender: divide gain by full number of policy years since
outset
o Onshore policies, partial surrender: divide gain by full number of policy years
since last chargeable event
o Offshore policies (pre 6 April 2013): divide gain by full number of policy years since outset
o Offshore policies (6 April 2013 onwards):
- If UK resident whole time: divide gain by full number of policy years since last
chargeable event
- If not UK resident whole time: divide gain by number of full policy years since
outset and make reduction for years of non-residence

Step 4: Calculate tax due on annual equivalent and deduct 20% to give relieved liability

Step 5: Deduct relieved liability from step 2 to give top-slicing relief

Question 23

UK Life Assurance Policies

Administering Tax

Time apportionment relief

Traded Endowment Policies (TEPs)

Answer 23

Administering Tax
 Life office issues certificate to policyholder on chargeable event
 Certificate enables completion of self-assessment

Time apportionment relief
 Gain reduced by no. days policyholder non-UK resident divided by no. days policy run
 Example, if non-resident 3 / 10 years, gain reduced by 30%

Traded Endowment Policies (TEPs)
 Policies can be traded on open market as second-hand policies
 No tax if qualifying policy traded after 10 years

Question 24

UK Life Assurance Policies -

Offshore Life Assurance Policies

Returning Ex-Pats

Onshore v Offshore

Answer 24

 Gross roll-up - usually established in low tax countries so investment rolls up free of tax
 May be withholding tax (non-reclaimable)
 Policyholder liable to income tax at highest rate on whole of gain
 PSA available
 Time apportionment relief for periods of non-UK residency
 Number of years for top slicing reduced for periods of non-residency

Returning Ex-Pats
 Consider encashing policy whilst still non-UK resident

Onshore v Offshore

1. Onshore
   - Higher rate taxpayers - 20% on net return of fund
   - Additional rate taxpayers - 25% on net return of fund
2. Offshore
   - Higher rate taxpayers - 40% on gross return of fund
   - Additional rate taxpayers - 45% on gross return of fund

 Tax representatives - appointed by offshore life offices/responsible for issuing chargeable gain certificates

Question 25

Overseas Life Assurance Business (OLAB)

Answer 25

 Of a UK life office only taxed on profits made on writing overseas business
 Not taxed on income and gains from investment in OLAB funds
 OLAB - only with non-UK residents
 OLAB policies not qualifying - treated as offshore life policies

Question 26

Friendly Society Policies

Answer 26

 Able to sell exempt policies
 Qualifying policies with limited premiums
 Funds are free of UK tax
 Limits - £270pa/£25pm
 Under 18s = baby bonds

Question 27

Structured products

Answer 27

 Investment returns linked to equity investments (usually an index)
 Returns achieved through combination of deposit/fixed interest investments and derivatives
 Capital bonds generally provide minimum guaranteed return
 Income bonds are mostly no longer available
 Generally sold in tranches
 May receive income or gains – if gains can use CGT AEA, if income then tax liability is deferred if interest rolls-up. If held in ISA/ pension, then no tax due
 May reduce IHT payable due to illiquid nature – may be worth less on death than they will on later maturity

Question 28

Pensions

Registered Pension Scheme Privileges

Contributions

Tax Relief on Contributions

Carrying Forward Annual Allowance

Max Benefits

Answer 28

 Registered Pension Scheme Privileges:
o Tax relief on input
o No CGT on gains or investment income within fund
o 25% of fund tax free on crystallisation
o Tax free death benefits before age 75 (within limits)

 Contributions:
o Employed and self-employed - tax relief on contributions up to 100% of earnings o Employer and employee contributions - up to annual allowance £40,000
o Subject to tapered annual allowance (min £4,000) for those with total income in excess of £240k (reduced by £1 for every £2)
o Low/no earnings - £3,600 per annum with basic tax relief

 Tax Relief on Contributions
o Net pay method - contributions deducted from pay before calculating tax
o Relief at source - contributions net of 20% tax (higher relief claimed from HMRC)
o Pre-July 1988 retirement annuity contracts and GP/dentists who are taxed as self-employed and also members of NHS pension scheme claim relief via self- assessment

 Carrying Forward Annual Allowance
o Any unused part of the annual allowance from previous 3 years – 2020/21, 2019/20 and 2018/19 for 2021/22 - can be carried forward and added to the current year’s allowance
o Pension Input Period - in line with tax year since 2017/18

Max Benefits
 Lifetime limit £1.0731m (2021/22)
 Max tax free cash - 25% of fund
 Retirement date - earliest age 55
 Death benefits before 75 - usually tax free up to lifetime allowance

Question 29

Pension Retirement Income

Pension Investments

Pension Planning

Answer 29

Pension Retirement Income
 Occupational schemes - scheme pension
 Individual schemes - secured pension (annuity) or capped/flexi-access drawdown
 No longer requirement to crystallise benefits
 PCLS can be taken at any time, but only alongside ‘relevant’ pension
 Transfers to charity are tax free

Pension Investments
 Residential property and tangible moveable assets trigger tax charge
 Max borrowing - 50% of net value of fund
 Pension fund taxation - tax free on gains and investment income

Pension Planning
 Greatest value where tax relief on contributions is greater than tax on benefits
 Employer contributions and pension benefits are not subject to NICs
 Non-earners (including children) can pay contributions of £3,600 and receive tax relief
 Make pension contributions to remove dividends from higher tax rates, increase basic
rate band and reduce gains taxed at 20%/28%

Question 30

Annuities

 Purchased Life Annuity (PLA):

 Purchased Annuities Certain

 Pension / Lifetime Annuity

 Deferred Annuity

 Annuities for Beneficiaries

 Cash Sum Payable Under Guaranteed Annuity

 Structured Settlements

 Immediate Needs Annuity

Paying Annuities Gross

Answer 30

Annuities

 Purchased Life Annuity (PLA):
o Capital content tax free,
o Interest element treated as savings income and taxed @ 20%
o Capital content based on purchase price divided by number of year annuitant
expected to live (mortality tables prescribed by HMRC) ]

 Purchased Annuities Certain
o Fixed term
o Capital content tax free
o Interest element treated as savings income and tax and taxed @ 20%
o If annuity is paid to someone other than person who paid purchase price, then no
tax-free capital content

 Pension / Lifetime Annuity
o Taxed in full as earned income

 Deferred Annuity
o Taxed as PLA when annuity taken

 Annuities for Beneficiaries
o Under a trust or will, taxed as full investment income, basic rate deducted at source

 Cash Sum Payable Under Guaranteed Annuity
o Tax-free

 Structured Settlements
o Annuity paid in settlement of claim for damages, paid without deduction of tax
and not taxable in hands of recipient

 Immediate Needs Annuity
o No income tax liability if used for long-term care and payments made direct to care provider

Paying Annuities Gross
 Complete HMRC form R89 if total income doesn’t exceed personal allowance