Indirect investments Flashcards
Child trust funds
Most children born after 31 August 2002 but before 3 January 2011, were entitled to a CTF. The Government used to provide an initial voucher of between £50 and £250. A further £9,000 a year can be added until the child’s 18th birthday.
There are three main types of account, available from a large number of providers:
• Savings accounts.
• Accounts that invest in shares.
• Stakeholder CTF accounts. These invest in shares but in such a way as to minimise the risk. Charges are limited to 1.5% a year.
CTF accounts can be moved between providers, and savings kept in a CTF can be transferred to a Junior ISA.
The funds cannot be withdrawn before the child’s 18th birthday except if the child is terminally ill. Once children are 18, the money will belong to them to spend or invest however they want, but no further savings can be added to the account. Maturing CTFs can be transferred into an ISA without this counting against the normal ISA subscription limit.
Child trust fund contributions
Parents and others can contribute to a child’s CTF up to a total of £9,000 in the 2020/21 tax year. The contribution limit applies to each year separately and cannot be carried forward to a later year.
• The start date for each year is the child’s birthday.
• Accounts set up for eligible children born before 3 January 2011 continue to benefit from tax-free investment growth and are subject to the withdrawal restriction.
Tax treatment child trust funds
The investment grows free of income tax and CGT. Investments in a CTF are exempt from the rule under which a parent is taxable on an unmarried child’s investment income of more than £100 gross in a tax year if the capital came from the parent.
UK collectives
Like investment trusts, unit trusts and OEICs allow individual investors to participate in a large portfolio of shares with many other investors. They can be bought and held by individual investors or within other tax wrappers, including pensions, ISAs and even other collectives (in the form of funds of funds). In many respects, UK collectives are taxed in the same way as direct investments, but there are some important differences.
• Investors buy units in a unit trust or shares in an OEIC.
• There are many different types of fund. For example, funds that concentrate on a particular market sector, funds that aim for high income or for high capital growth, and balanced funds.
• Unlike investment trusts, unit trusts and OEICs are open-ended. Units or shares are issued when investors invest and liquidated when investors redeem their holdings by selling them back to the fund manager.
• There is usually an initial charge on purchase of units or shares and an annual management fee.
• The taxation of dividends from OEICs and equity unit trusts is the same as the taxation of dividends on shares.
• Income from non-equity unit trusts, and OEICs that invest in fixed-interest securities, is taxed as savings income and is paid gross.
• Gains on disposal of unit trust units and OEIC shares are liable to CGT, and losses are allowable.
Offshore reporting funds
UK investors are subject to income tax on their share of the fund’s income, whether it is distributed or not.
– Equity distributions are taxable at the dividend rates (7.5% basic rate, 32.5% higher rate and 38.1% additional rate) and are eligible for the £2,000 dividend allowance.
– Interest distributions are taxed at 0% starting rate, 20% basic rate, 40% higher rate and 45% additional rate. The personal savings allowance (£500 or £1,000 as appropriate) is available.
• Any profit on the eventual encashment is subject to the normal CGT rules, and will be taxed at a rate of 10% and/or 20%.
To all intents and purposes, as far as the individual investor is concerned, reporting funds are taxed in the same way as UK collectives.
Offshore non reporting
Any fund that has not obtained reporting fund status is a non-reporting fund.
• Any income that accrues to the fund is usually accumulated. Income is not taxed as it
arises, only on disposal of units/shares.
• The gain (called an offshore income gain) on any disposal, including on the death of the investor, is calculated on CGT principles (without the annual exempt amount), but is subject to income tax in the tax year of encashment. Any income that has been accumulated will constitute part of the gain.
• Because the gain is liable to income tax it is charged at the 20% basic rate, the 40% higher rate or the 45% additional rate. The personal savings allowance, the dividend allowance and the starting rate for savings income cannot be used against the gain.
Compare reporting and non reporting tax treatment
Reporting funds are generally preferable for most UK investors because of the lower tax rates on equity distributions and the 10% or 20% CGT rate on the gain. Because the income is received gross, non-taxpayers do not have to go to the trouble of reclaiming tax.
However, non-reporting funds have some advantages:
• Income can be accumulated in a low tax environment so the investment can grow faster.
• UK investors can roll up income and realise profits, perhaps when they are paying only a relatively low rate of tax or they have become non-UK resident.
• For investors who are not resident in the UK, offshore income and gains are free of UK tax; however, they may be taxable in the investor’s own country of residence.
• For UK-resident but non-UK-domiciled investors, income and gains not remitted to the UK escape UK tax liability if they elect to be taxed on the remittance basis. However, they may have to pay the annual remittance basis tax charge.
• Offshore investments are excluded property for non-UK-domiciled investors and so escape UK inheritance tax (IHT).
Protected and guaranteed (structured) equity products
Protected and guaranteed (structured) equity products provide investment returns that are linked to the performance of equity investments – usually an index such as the FTSE 100 – with some element of the return protected or guaranteed.
The returns are usually achieved by providers using a combination of a deposit or fixed- interest investment and a derivative of the chosen index or equities.
• Growth products generally provide a guaranteed minimum return – typically the return of the original investment, sometimes with a low rate of interest – plus some proportion of the growth in the value of the chosen index.
• Income products are no longer that common. They usually provided a fixed income and the return of capital at the end of the term was linked to the performance of the chosen index/equities. Typically, returns of the full initial sum invested were conditional on the chosen index/equities not falling in value by more than a given percentage.
These products change over time as providers make innovations to their offerings. The products are sold in tranches rather than on a continuous basis because the terms change with movements in the pricing of derivatives that underlie the products’ performance.
Structured products - income or capital
Income or capital
Depending on the choice of product, an investor can receive either income or chargeable gains. The advantage of having chargeable gains is that the investor can make use of their annual exempt amount (£12,300 for 2020/21), thereby sheltering gains from tax.
• Some products will roll up the return and pay out at the end of the product’s term. This means that any tax liability is postponed, which could be useful if a lower rate of tax is expected to be payable for future years.
• The use of the CGT annual exempt amount could be maximised by investing in a series of products maturing in successive tax years.
• Structured products can also be held within ISAs or self-invested personal pension schemes (SIPPs), with the result that all investment returns will be tax free.
Structured products IHT
Structured products are generally illiquid investments because of their fixed-term nature, but this can make them useful for IHT mitigation where an investor does not expect to live for much longer. For example, an investment of £100,000 might only have a probate value of £80,000 one year after making the initial investment – despite aiming to pay out a much higher sum at the end of the product term. The investment would therefore reduce the investor’s estate by £20,000, saving IHT of £8,000 (£20,000 × 40%). The beneficiary will eventually receive the higher sum payable when the product matures.
Closed-ended investment companies
These issue special classes of shares and are based in offshore financial centres, e.g. Dublin.
• Income is treated as dividend income. Subject to the £2,000 dividend allowance, basic- rate taxpayers are liable to 7.5% tax, higher-rate taxpayers are liable to 32.5% tax and additional-rate taxpayers are liable to 38.1% tax.
• Chargeable gains are subject to CGT in the normal way.
• The investments can be held in ISAs.
Listed bonds or medium-term notes (MTNs)
Fixed-term contracts typically issued by UK or other EU banks.
• The income is taxed as savings income so any available part of the £5,000 starting rate band for 2020/21 can be used against the income, which will be taxed at 0%.
– The personal savings allowance (£500 or £1,000, as appropriate) is then available, except to additional-rate taxpayers.
– After that, basic-rate taxpayers are taxed at 20%, higher-rate taxpayers at 40% and additional-rate taxpayers at 45%.
• Chargeable gains are subject to CGT in the normal way.
• They can be held in an ISA.
