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AF4/J10 > Investment Taxation > Flashcards

Investment Taxation Flashcards

1
Q

What is the starting rate for savers?

A

If your other income is less than £17,570:

Your starting rate for savings is a maximum of £5,000. Every £1 of other income above your Personal Allowance reduces your starting rate for savings by £1.

Example

You earn £16,000 of wages and get £200 interest on your savings.

Your Personal Allowance is £12,570. It’s used up by the first £12,570 of your wages.

The remaining £3,430 of your wages (£16,000 minus £12,570) reduces your starting rate for savings by £3,430.

Your remaining starting rate for savings is £1,570 (£5,000 minus £3,430). This means you will not have to pay tax on your £200 savings interest.

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2
Q

How do you calculate AER? what is the optimum time period for accruing interest?

A

(1+r/n)^n-1

The more regularly interest is accrued, the better.

i.e. Interest accrued daily is better than yearly.

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3
Q

Risks of cash?

A

Default risk

Deposits held in EEA are not protected by FSCS

Inflation risk - real rate is poo (inflation minus interest) and inflation erodes purchasing power

Re-investment risk - not able to secure same level of interest

Negative interest rates

Exchange rate movements

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4
Q

Of the following products is interest paid gross or net and is it taxable:

Deposit Accounts

Cash ISA

NS&I: Prem bonds, certificates, Direct ISA, Junior ISA

NS&I: Guaranteed growth bond and income bond, direct saver, investment account

A

Deposit Accounts = paid gross taxable

Cash ISA = paid gross, tax free

NS&I: Prem bonds, certificates, Direct ISA, Junior ISA = paid gross, tax free

NS&I: Guaranteed growth bond and income bond, direct saver, investment account = paid gross, taxable

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5
Q

Factors affecting bond prices?

A

Inverse relationship with interest rates

Specific or commercial risks, gov bonds more secure than corporate

Systematic risk

Volatility

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6
Q

Risks of equities?

A

Equity capital risk

Dividend Volatility

Currency risk

Liquidity risk - can’t sell investment

Counterparty risk - AJ Bell fails

Regulatory risk

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7
Q

Difference between a unit trust and an OEIC?

A

A unit trust is governed by trust law, whereas an OEIC is governed by company law; technically, this means investors in a unit trust are not owners of the underlying assets, unlike investors in an OEIC

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8
Q

How do you calculate the offer/buy price of a unit trust?

A

Market value of underlying shares + Dealing costs + trust assets (Cash, income etc.)

-

Tax + fees + charges/expenses

+

Initial charge

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9
Q

How do you calculate bid/selling price of a unit trust?

A

Fund value at market selling price + income

-

Charges (broker) + AMC - audit fees

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10
Q

How do you calculate buy and selling price of unit trust

A

NAV / # units in existence

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11
Q

Characteristic of investment trusts?

A

Issues fixed number of shares (closed ended)

Regulated by company law

Shares traded on LSE

Able to gear - borrow money to purchase further stocks

External management i.e. Baillie Gifford

Share price depends on supply and demand

Value is not based purely on NAV, as trust shares can trade at a discount

High investment risk as IT trade at a discount to NAV which can drop lower than just underlying value of shares of IT

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12
Q

How do you calculate the NAV of an IT?

A

Equal to total value of all investments within the trust less any liabilities.

Total value of listed assets at mid market price + unlisted investments + cash or other assets

minus

value of loans + debentures and preference shares

= shareholders funds

shareholders funds / no. ordinary shares in issue = NAV

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13
Q

Outline six main reasons why a financial adviser would use an investment trust rather than an open-ended investment company (OEIC)

A

Charges likely to be lower.
Gearing/borrowing.
Discount/price arbitrage/higher running yield.
More flexible/less diversification.
Ability of board to change/select manager.
Greater accessibility/liquidity/do not have to sell underlying investments.
More suitable structure to hold specialist/niche investments/wider range of investments.
Dealing frequency/real-time pricing

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14
Q

How do you calculate the simple NAV of an investment trust?

How do you then calculate the discount/premium?

A

Total capital employed - debt / shares in issue = gearing ratio / NAV

NAV- Share Price / Share Price

If an investment trust has a NAV of 250p and is trading at 225p, then it is trading at a discount of 10% to its NAV, i.e. (250 – 225) ÷ 250.

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15
Q

How do you calculate the diluted NAV per share?

A

Warrants issued x warrants subscription price = x

x + shareholder funds = y

y / (shares in issue + warrants)

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16
Q

Advantages and Disadvantages of property investment

A

Advantages:
Diversification
Gearing
Income Stream

Disadvantages:
Interest rate risk
Capital / market risk
Liquidity risk: unable to sell at specific time
Income / tenant risk

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17
Q

What is a REIT?

A

A REIT is an investment vehicle that has a tax treatment that is closely aligned to the tax arrangements in place for direct investment in property.

A REIT is Close ended.

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18
Q

State the main rules that a fund must adhere to in order to qualify as a REIT.

A
  • UK resident/listed.
  • Closed-ended/only one share class.
  • Must be listed on stock exchange
  • 75% of the company’s total gross profits have to originate from property letting.
  • Interest on borrowing has to be at least 125% covered by rental profits
  • At least 90% of the rental profits from each accounting period must be paid as a dividend to investors.
19
Q

Distributions from REITs consist of two elements:

A

A payment from the ring-fenced element that is exempt from corporation tax, which is classed as property income and is typically paid net of 20% tax. (Paid gross in an ISA/SIPP)

A dividend payment from the element that is not exempt from corporation tax, which is taxed as any other UK dividend.

20
Q

Advantages of a REIT?

A

Diversification
Professional Management
Less direct administration
Liquidity
Partial Sale
Possibility of smaller / regular investments
Investor protection via increased regulation
Potential CGT savings

21
Q

Risks to consider on disposal of a REIT?

A
  • REIT subject to supply and demand/closed-ended fund;
  • in a weak market may be heavily discounted/trade at discount to net asset value;
  • in extreme conditions or with smaller trusts there may be no buyers/stock could become illiquid.
22
Q

What is a PAIF?

A

A property authorised investment fund (PAIF) is an FCA-authorised OEIC that invests mainly in property (including UK and non-UK REITs). The point of taxation moves from the fund to the investor, in the same way as would apply to a direct investment in property.

PAIFS are open ended

23
Q

What are the three income distributions from a PAIF

A
  1. property income – this is usually paid net of 20% income tax (non-taxpayers can reclaim the tax or it can be paid gross, if the fund is held within an ISA or a pension wrapper, the income is also paid gross)
  2. interest income – distributions of interest are paid gross
  3. dividends – paid without the deduction of any tax, i.e. they are also paid gross
24
Q

What the main conditions which have to be met for a PAIF

A
  • At least 60% of the PAIF’s net income in an accounting period must be from the exempt property investment business.
  • At the end of each accounting period, the value of the assets involved in the property investment business must be at least 60% of the total assets held by the PAIF.
  • Its shares must be widely held, with no corporate investor holding 10% or more of the fund’s NAV.
25
Q

Risks to consider on disposal of a PAIF

A
  • Managers may not have sufficient cash to pay sellers.
  • Managers may not be able to sell property/forced to sell property below market price/ cheaply;
  • Move to weekly valuations.
  • Apply fair value pricing.
  • Apply dilution levy.
  • Apply fund dealing suspension.
26
Q

Income tax relief by using an EIS?

A

Income tax relief at 30% for qualifying investments.

No min into EIS however tax relief is limited to £1m per year (£300,000), £2m for knowledge-intensive companies.

Shares must be held for at least three years from the date of issue or the tax relief will be withdrawn.

If shares are disposed of at a loss, the investor can elect that the amount of the loss - less Income Tax relief - can be set against income of that year or the previous year.

27
Q

Capital Gains reinvested relief for using an EIS?

A

A gain made on the sale of other assets can be reinvested in EIS shares and deferred over the life of the investment.

There’s no upper limit on the value of gains that can be deferred.

It’s the gain, not the proceeds of the sale that should be reinvested. For example, if an asset was sold for £50,000 and cost £10,000, this would result in a gain of £40,000. This £40,000 would need to be reinvested in EIS-qualifying shares in order to defer the gain.

To qualify for deferral relief, the reinvestment into EIS-qualifying shares needs to be made no earlier than 12 months prior to, or three years after, the original gain was made.

The gain will be deferred until the earliest of any of the following events:

The EIS shares are sold.
The company ceases to be EIS-qualifying within three years of investment.
An investor ceases to be a UK resident within three years of investment.

When the deferred gain comes back into charge, it’s subject to capital gains tax at the relevant rate at that time.

28
Q

Capital Gains Relief for using an EIS?

A

If an investor holds EIS shares for at least three years, any capital gain realised on the disposal of the shares will be capital gains tax free, provided income tax relief has been given and has not been withdrawn.

AND THE ORIGINAL INVESTMENT WASNOT A DEFERRED GAIN

29
Q

Explain briefly the CGT rules of any new investment into an EIS, if the investment were made with the proceeds from the sale of the shares.

A
  • Existing gain;
  • deferred until disposal;
  • without limits/unlimited;
  • can be deferred again.
  • New gain;
  • exempt from CGT;
  • after 3 years;
  • if Income Tax relief obtained.
  • Loss relief available;
  • offset against income or gains
30
Q

Income Tax relief by using SEIS (seed)?

A

50% back of the amount you invest as a reduction in your Income Tax bill up to a maximum of £200,000 invested, providing £100,000 of tax relief.

For example, say you invested £10,000 in an SEIS-eligible company. When you file your tax return, you list the details of your SEIS-qualifying investment to reduce your Income Tax bill by £5,000.

shares must be held for a period of three years from the date of issue for relief to be retained. If they are disposed of within the three-year period, relief will be withdrawn or reduced.

31
Q

Capital Gains reinvestment relief by using SEIS (seed)?

A

CGT re-investment relief can apply if income tax relief is claimed. This relief reduces capital gains made on disposal of other assets by 50%.

The maximum gain reduction is £100,000 per annum (50% of £200,000). The gain must arise in the tax year in respect of which SEIS income tax relief is given (i.e. either in the tax year of investment or the preceding tax year if a carry back claim is made). The remaining 50% of the gain remains chargeable.

For example: this would mean that, should an additional or higher rate taxpayer sell shares gained other than the SEIS and realise a £40,000 gain, where usually they would be liable to pay £8,000 in CGT (20%), using SEIS reinvestment relief, should they reinvest the full sum of the gain into SEIS qualifying shares, this charge would be reduced by 50%, saving the individual £4,000.

32
Q

Capital Gains relief by using SEIS (seed)?

A

When you come to sell your shares, usually you’d pay Capital Gains Tax on the profit you make, so long as income tax relief has been granted.

33
Q

Calculate the Income Tax and CGT reliefs that could be claimed by investing the maximum amount into a new SEIS.

A

Income Tax relief
£200,000 x 50% = £100,000

CGT reinvestment relief
£100,000 x 20% = £20,000 (28% if property)

CGT deferral relief
£100,000 x 20% = £20,000

34
Q

Tax advantages of using VCT

A

Dividend relief: dividends from ordinary shares in VCTs are exempt from income tax for investments of up to £200,000 per tax year.

Income tax relief: available at the rate of 30% for purchases of newly issued VCT shares up to a maximum of £200,000 per tax year. Income tax relief is clawed back if the shares are not held for at least five years.

Disposal relief: capital gains made on the disposal of shares in a VCT are free of capital gains tax (CGT) at any time, provided that the VCT was approved both when the shares were acquired and when they were sold, and the investor is aged 18 or over when selling the shares

35
Q

Irma receives an income payment of £2,950 from the REIT, consisting of £750 property income distribution and a £2,200 dividend.

A

PID
(£750 / 80) x 100 = £937.50
£937.50 x 20% = £187.50

Dividend
£2,200 - £1,000 = £1,200
£1,200 x 33.75% = £405.00

Total £187.50 + £405.00 = £592.50

36
Q

Explain the main differences between undertakings for collective investment in securities (UCITS), and unregulated collective investment schemes (UCIS) that can result in UCIS having higher risk.

A
  • UCITS FCA authorised/UCIS not authorised * for marketing to retail clients.
  • UCITS benefit from better liquidity.
  • UCITS subject to COLL/FUND sourcebooks.
  • UCITS has higher levels of transparency/disclosure.
  • UCITS subject to borrowing restrictions.
  • UCITS has greater diversification/spread of risk.
  • UCIS likely to invest in higher risk underlying assets.
  • UCIS unlikely to have FSCS protection/lack of investor protection.
37
Q

State five types of investor to whom UCIS may be promoted.

A
  • Existing holders.
  • Certified high net worth individual (HNWI) investors.
  • Enterprise/charitable.
  • Eligible employees of the fund.
  • Eligible counterparty or professional client.
  • Certified/self-certified sophisticated investors.
38
Q

Explain the safeguarding regulations in place that govern UCITS in respect of:

Diversification

Borrowing.

A

Diversification:
* Not more than 10% value of fund invested in any one company.
* No more than four companies at maximum/holdings over 5% cannot exceed 40% in total.
* Remainder, maximum 5% of fund value resulting in minimum of 16 holdings.
* Max 10% unquoted companies.

Borrowing:
* Borrowing only/normally not permitted up to 10% on a temporary basis/up to three months if supported by expected receipts.

39
Q

Explain briefly the terms ‘fettered’ and ‘unfettered’.

A

Fettered
* Only/solely/exclusively;
* in-house range funds.

Unfettered
* Unfettered funds can use funds from other managers/third party;
* as well as their own.

40
Q

State and explain one relative advantage of funds being fettered and unfettered.

A

Fettered Advantage
* Can be cheaper/lower costs to run;
* as no additional charge over and above existing underlying fund charges is allowed/no charges above the standard annual management charge (AMC) allowed.

Unfettered Advantage
* Not restricted/broader choice of funds/managers/sectors;
* if one fund fails to perform it can be replaced as wide universe available.

41
Q

Explain briefly how the manager of managers fund arrangement works.

A
  • Overall manager decides on asset allocation.
  • Appoints manager for each sector/objective/proportion of the fund;
  • and monitors its performance.
  • Can replace managers/new manager takes over the existing assets.
  • Funds are segregated;
  • and discretionary.
42
Q

Identify two advantages and two disadvantages of the manager of managers arrangement in comparison to the fund of fund arrangement.

A

Advantages
* Bespoke mandate/overall manager has say in investments.
* No requirement to sell a fund and buy a new one.
* Can replace managers.

Disadvantages
* The new manager, is however, left with whatever his predecessor chose to buy;
* limited number of managers willing to run mandate.

43
Q

Describe briefly what is meant by the OCF in respect of a collective fund.

A
  • Single;
  • percentage figure;
  • that shows the;
  • annual cost of;
  • investing in/owning a fund.

AF4/J10 (9 decks)

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