Indirect investments part 2

Question 1

Qualifying life policies

Answer 1

level premiums payable at least annually for at least ten years. For qualifying policies issued on or after 6 April 2013, an individual’s premiums across all policies are restricted to £3,600 per year.

Question 2

Non-qualifying policies

Answer 2

Non-qualifying policies are broadly single premium policies that are usually taken out primarily as investments (e.g. life assurance investment bonds) rather than for life cover.

Question 3

Life company taxation

Answer 3

• The fund pays tax at 20% on interest income, property rental income and offshore income gains. UK dividends are generally exempt from tax.
• If the fund sells any assets at a profit, it pays tax on any gain at 20%
• These taxes are paid directly by the life office, so do not involve the policyholder and cannot be reclaimed by any policyholder.

Question 4

Policyholder taxation

Answer 4

Qualifying policies are treated much more favourably because only gains arising when a policy has been paid up or surrendered within the first ten years are taxable, whereas all gains under non-qualifying policies are taxable. Tax is only payable if:
• a chargeable event occurs;
• a chargeable event gain arises; and
• when the gain is added to the taxpayer’s other taxable income for that year, all or part of it falls within the higher or additional rate tax brackets. An additional tax liability may also arise where the taxpayer is entitled to tax credits, where the gain results in the personal allowance or married couple’s allowance being reduced or lost, or where the gain creates or increases a child benefit income tax charge.

Question 5

The chargeable events for a qualifying life policy are:

Answer 5

If within ten years of the policy term (or three-quarters of the term if sooner, unless due to death or disability) there is a full or part surrender, an assignment for money or money’s worth, or a policy loan is made (where the policy was taken out after 26 March 1974).
• If within ten years of the policy term (or three-quarters of the term if sooner, unless due to death or disability) and the policy has been converted into a paid-up policy within that period, death or maturity.
• The time limits run from the start of the policy or from any variation by which premiums are increased, unless the increase is solely because of a variation in the life or lives assured when a replacement policy is issued with no other changes to the policy, or the exercise of an option in a policy entered into on or after 1 April 1976.
• If a loan is a chargeable event, it is treated as a part surrender and the gain is calculated under the rules for part surrenders.

Question 6

Administration of the tax on bonds

Answer 6

Whenever a chargeable event occurs and a gain arises, the life office has to issue a certificate to the policyholder:
• The certificate must contain specified information, including the amount of chargeable gain, to allow the policyholder to complete their self-assessment tax return.
• A copy must be issued to HMRC if:
– the chargeable event was an assignment for money or money’s worth; or
– the amount of the gain, including any connected gain (e.g. via cluster policies) exceeded half of the basic rate limit (i.e. more than £18,750 in 2020/21).
• HMRC has the power to audit insurance company systems to check that they are producing the required certificates. There are regulations that specify the records that insurance companies must keep to allow HMRC to carry out those audits.

Question 7

Taxation of gain on bonds

Answer 7

The gain is subject to the higher or additional rate of income tax, minus the basic rate. This means a higher-rate taxpayer will pay income tax of 20% (40% – 20%) and an additional- rate taxpayer will pay 25% (45% – 20%). Because gains are classed as savings income, the personal savings allowance and the starting rate of 0% may be available when calculating the tax on a gain.

Question 8

Immediate needs annuity

Answer 8

There is no income tax liability on the annuitant where:
• an impaired life annuity is used for long-term care (often called an ‘immediate needs annuity’); and
• payments are made direct to the care provider in circumstances where the provider has a legal right to them.

Question 9

Purchased life annuities

Answer 9

Split into Capital/Interest element
Capital element = tax free
Interest element=taxable as SAVINGS
The capital content of each payment is fixed at the outset and remains constant throughout the duration of the annuity.

Question 10

Purchased annuities certain

Answer 10

Payable for set term death or not
• The purchased life annuity treatment is not available to annuities certain, because they do not depend on human life.
• Nevertheless, they are treated as comprising part capital and part interest, with only the interest content being taxable.
• As the annuity has a fixed term, the total payment is known in advance and the capital content can be easily calculated by dividing the purchase price by the number of payments.
• Tax is deducted from the interest content at the basic rate of 20%.
• There is no tax-free capital content if the annuity is paid to someone other than the person who provided the purchase price. The reasoning is that if the annuitant has not paid for the annuity, there can be no return of capital. Such an annuity would thus be wholly taxable.

Question 11

Pension annuities

Answer 11

If an annuity is being paid as a result of a pension scheme, personal pension or self- employed retirement annuity contract, it cannot be accorded purchased life annuity treatment and is taxable in full.
Pension income
Pension annuities are taxed under the Income Tax (Earnings and Pensions) Act 2003.

Question 12

Annuities for beneficiaries under trusts or wills

Answer 12

An annuity cannot be treated as a purchased life annuity if it has been purchased from a life office for the beneficiary under a will or trust.
• Annuities purchased as a result of a direction in a will or settlement are specifically excluded from purchased life annuity treatment.
• The life office deducts basic rate income tax from the whole annuity payment and the beneficiary may also be subject to higher or additional rate tax, if applicable.
• If an annuity is payable under a direction in a will, the beneficiary can legally demand the capital value of the annuity. If this is paid out as a cash lump sum, the individual could then buy an annuity on their own behalf and thus gain the benefit of purchased life annuity treatment.

Question 13

Annuity tax admin

Answer 13

HMRC has made arrangements with life offices for annuities to be paid without deduction of tax in certain circumstances, to avoid large numbers of small repayment claims.
• This treatment only applies where the annuitant’s total income is such that they are unlikely to have to pay any income tax.

ALSO

An annuity payable to an annuitant resident abroad may be subject to UK tax and also to tax in the country of residence.
• This double taxation may be reduced or eliminated if there is a double taxation treaty between the UK and the other country.

Question 14

Offshore life policies

Answer 14

liable to income tax at their highest rate(s) on the whole of their gain
The perceived advantage of these policies is the gross roll-up, compared with onshore policies where the life fund suffers tax at 20% on non-dividend income and capital gains. This may be of particular value to a higher rate or an additional-rate taxpayer in the longer term.
Relief is given by reducing the chargeable gain by the following fraction:
Number of days policyholder was not resident in the UK/Number of days policy has run

Question 15

Tax reduction on offshore life policies

Answer 15

The charge is reduced to higher rate less basic rate or additional rate less basic rate if:
• the insurer is based in a country that is a member of the EEA;
• in its home state the insurer is taxed on the investment income and gains accruing for its UK policyholders at a rate of not less than 20%; and
• the insurer has not reinsured the investment content of the policy.

Question 16

Offshore and onshore bonds compared

Answer 16

For onshore bonds (after taking account of the personal savings allowance and the starting rate of 0%), gains are taxed at 20% for higher-rate taxpayers and 25% for additional-rate taxpayers, under the chargeable event gains rules when the bond is cashed. With an offshore bond, an investor who is a basic-rate taxpayer will pay 20%, a higher-rate taxpayer will pay 40% and an additional-rate taxpayer will pay 45% tax on the gain when the bond is cashed.
• Some investment income received by an offshore fund may be received after deduction of non-reclaimable withholding tax, reducing the effect of the gross roll-up. There would be no credit for the withholding tax in calculating the chargeable gain, leading to possible double taxation.
• In an onshore fund, management expenses are generally deductible from the fund’s income for tax purposes. An offshore fund has no tax from which to deduct management expenses, thus reducing the effect of gross roll-up.
With an onshore bond, the 20% or 25% tax is charged on the net return of the fund, whereas with an offshore bond, the 20%, 40% or 45% tax is on the gross return.

Question 17

Personal portfolio bonds

Answer 17

HMRC has long disliked personal portfolio bonds and acted against them by imposing a penal tax on deemed gains.
• The deemed gain is 15% of the total premiums paid at the end of a policy year, plus the total deemed gains from previous years (minus any chargeable withdrawals). The effect of this is to tax the policyholder as if the investment were yielding 15% compound per year, regardless of the actual growth or, indeed, any fall in value.

Question 18

Tax of life policies in trust

Answer 18

If a chargeable event happens -

If settlor alive and UK res then tax on them. This can be recovered from trustees.

If settlor dead or abroad, then on trustees. The charge is at trust rates, which (for a discretionary trust) are 45% for income above the trust’s standard rate band and 20% within it.

Onshore gets 20% tax credit, offshore doesn’t.

If they are not resi then it’s benis.

Question 19

The additional 25% tax charge on the settlor or the trustees can be avoided if the beneficiaries are adult non-taxpayers or basic-rate taxpayers. This can be achieved by arranging for the trustees to assign the policy to the beneficiaries for the beneficiaries to trigger the chargeable event. Following the assignment by the trustees, the policy could then be cashed in by the beneficiary (who is now the assignee and legal owner) and tax would be chargeable on them, rather than the settlor or the trustees. If the beneficiary remained a basic-rate taxpayer after adding the gain to their other income, no further income tax liability would arise for a UK policy. If the gain added to their other income caused them to be a higher- and additional-rate taxpayer, they would be able to benefit from top-slicing relief, which could eliminate any tax liability on an onshore policy. For an offshore policy, the beneficiary would be liable to tax at their marginal rate, but could also benefit from top-slicing relief.

Answer 19

Important to understand.

Question 20

CGT on life policies in trust

Answer 20

A life policy is only subject to CGT if it is assigned for actual consideration. This rarely happens with a trust policy.

Question 21

Inheritance tax on life policy in trust

Answer 21

Premiums are a transfer of value for IHT purposes!

Regular premiums are all value transfers unless Premium payments could be claimed as exempt under the ‘normal expenditure’ exemption.

For bare (or absolute) trusts, whenever created, the payment of the first premium will be regarded as a potentially exempt transfer (PET). Subsequent premiums will also be regarded as PETs to the extent that the value of the policy is increased.

For transfers into most other types of trust, the excess over any available exemption(s) is a chargeable lifetime transfer (CLT). The lifetime rate at 20% is payable on the excess if the CLT exceeds the settlor’s remaining nil rate band (i.e. £325,000 less the chargeable transfers made in the previous seven years). If the settlor dies within seven years, the tax charged is recalculated at the full (or death) rate. There may also be periodic and exit charges on the trust.

Question 22

Pre-owned assets tax

Answer 22

Tax when the donor retains an interest

For intangible assets, such as life policies held in trust, POAT is charged on an amount equal to interest at the ‘official rate’ (2.25% for 2020/21) on the value of the interest retained by the settlor, but only where the settlor is not subject to the GWR rules.
No charge is levied if the income does not exceed £5,000 in a tax year. over £5,000 is fully taxable at the settlor’s rate of income tax. So where the settlor’s total interests are valued at less than £222,222, the charge does not ‘bite’ (£222,222 × 2.25% = £5,000).

In the context of life policies, the vast majority of trusts are not subject to POAT. However, there are three types of trust that are.

Business trusts where the settlor is a potential beneficiary along with fellow partners or shareholders

Trusts established before 18 March 1986

Certain trusts that gave a temporary interest in possession to a spouse

Question 23

Real estate investment trusts

Answer 23

Have to be UK tax resident
Have to be closed ended
Have to be listed on stock exchange including AIM
75% of profits from property letting
interest on debt needs 125% rental coverage
90% of profits need to come from dividend

Question 24

Distributions from REITs consist of two elements:

Answer 24

1. A payment from the tax-exempt element.
   • For individual investors, this is classed as property income and paid net of 20% tax.
   • Non-taxpayers may reclaim the excess tax deducted.
   • ISA investors receive payments gross.
2. A dividend payment from the non-exempt element.
   • This is taxed as any other UK dividend.
   Gains on REIT shares are subject to CGT in the normal way for investors.

Question 25

Insurance company property funds

Answer 25

Life assurance companies generally have funds that specialise in direct holdings of property. They can usually be held through both regular and single premium life assurance policies.
The distinguishing features are:
• The values of units are directly linked to the underlying properties in the portfolios and are established by regular professional valuations.
• The funds are not geared through borrowing – unlike property companies.

Question 26

Property unit trusts, OEICs and investment companies

Answer 26

Similar to life assurance property funds

BUT they only pay CGT once gains are realised.

Question 27

Enterprise investment scheme

Answer 27

30% income tax relief up to £1m a year (£2m knowledge intense)
• Up to the amount that can be invested in one tax year (£1m or £2m) can be carried back to the previous year, subject to the maximum limit for that year not being exceeded.
• Disposals of qualifying shares at a profit are usually exempt from CGT, as long as the shares have been held for three years. Income tax or CGT relief is available for losses on such disposals (net of the tax relief given).
• For shares quoted on AIM and unquoted shares, IHT business relief is normally available after two years’ ownership.
• Investors must not be connected with the company or its trade when subscribing for shares, although they can subsequently become a paid director of the company. This enables an investor to have some control over the investment.

Question 28

Withdrawal of tax relief EIS

Answer 28

If shares are disposed of within three years, except to a husband, wife or partner in a civil partnership. However, relief is not withdrawn on death.
2. If an investor receives value from the company within a period starting one year before and ending three years after the issue of the shares or three years after the company started trading if later.
• Receiving value includes selling shares back to the company in any way and obtaining any loan, gift or similar benefit from the company.
• Normal dividends do not count as receiving value for this purpose.
3. If the company ceases to be a qualifying company in the first three years, such as no longer carrying on a qualifying trade.

Question 29

Capital gains tax deferral EIS

Answer 29

Individuals can defer chargeable gains on any assets by reinvesting the gain in shares that qualify under the EIS. This makes the maximum potential tax relief 58% (30% income tax and deferral of a CGT liability of up to 28% (for a residential property gain)).
• To claim this relief, the investor must be resident in the UK.
• The reinvestment must take place within a period starting one year before and ending three years after the disposal, giving rise to the chargeable gain.
• There is no upper limit on the amount of the gain that can be deferred.
• The deferred gain is brought into charge when the EIS shares are disposed of, unless a further qualifying reinvestment is made, or if the company ceases to qualify within
three years.
• The charge is triggered if the investor ceases to be UK resident within three years of the issue of the shares, unless the period of non-residence is a result of employment outside the UK and the investor returns to the UK within three years without having disposed of the shares.

Question 30

Seed enterprise investment scheme

Answer 30

The main differences from the EIS are as follows:
• Income tax relief is given at 50% on qualifying investments of up to £100,000 in a tax year.
• Provided they are not otherwise connected (under the 30% shareholding restriction), an investor is permitted to be a paid director at the time shares are subscribed for.
• The company must have been trading for less than two years, be carrying on a genuine new trade, have gross assets of not more than £200,000, and have fewer than the equivalent of 25 full-time employees.
• Investors can qualify for a 50% CGT exemption on gains that are reinvested in shares that qualify under the SEIS. For example, an investor who reinvests gains of £100,000 will pay CGT on only £50,000; the other £50,000 will be exempt from CGT. The reinvestment must take place in the same tax year in which the chargeable gain arises, or in the following tax year, in which case the relief must be carried back to the year of the chargeable gain (carry back is on the same basis as for the EIS).
• For someone paying CGT at the higher rate, the overall tax relief is 60% (50% income tax relief and 20% CGT exemption on 50% of a reinvested gain). Relief would be 4% higher where the reinvested gain would be subject to the 28% CGT rate for a residential property disposal.

Question 31

Venture capital trusts

Answer 31

income tax relief at 30% on investments of up to £200,000 per tax year in newly issued ordinary shares in VCTs.
• The relief is given by means of an income tax reduction, along the lines of EIS relief.
• Dividends from investments in VCTs of up to £200,000 per tax year are tax free.
• Individuals are also exempt from CGT when they dispose of VCT shares. The shares do not have to be held for any minimum period.
• Investors cannot defer capital gains by reinvesting in VCT shares.
• Income tax relief is withdrawn if the shares are disposed of within five years, except if the disposal is to a spouse or civil partner. Relief is not withdrawn on the death of an investor.