Investments

Question 1

Describe the benefits for Dan and Tara of having set up a limited company.

Answer 1

 Set up costs allowable against corporation tax
 Dan and Tara are most likely employees
 If they draw salaries above LEL they’ll accrue a new State pension and be eligible for some State benefits
 They could set their salaries between the LEL and the PCT
 This would save themselves and their employer (the limited company)
NICs, but they’d still get NI credits and therefore will accrue State pension
 Balance of profits can be paid as dividends enabling them to use their dividend allowance
 These are not subject to NICs
 Ltd company is a separate legal entity
 Reducing their personal liability
 Company can make pension contributions
 These are tax deductible and provide NIC savings
 They can make pension contributions themselves
 They can provide DIS/income protection / CIC/PMI for themselves through the company

Question 2

Describe the drawbacks for Dan and Tara of having set up a limited company.

Answer 2

 Higher ongoing costs than for self-employment
 No privacy – accounts in public domain
 Greater administration / reporting requirements
 May impact on ability to borrow in the future (a lender may only take into account salary rather than salary plus dividends)
 Dividend income does not count towards pension contributions

Question 3

Explain to Dan and Tara the potential tax implications of working from home.

Answer 3

 Without justification to HMRC, the company can pay them £26 a month / £6 a week to cover ‘use of home’ costs
 As an expense to the business, this is deductible for corporation tax purposes
 £6 a week is not classed as a benefit in kind for the employee so is not liable to income tax
 Alternatively, claim for incremental costs of expenses of working from home
 Or, draw up a rental licence between the couple and the company where the company pays market rent
 However, doing so is likely to mean losing the CGT principle residence exemption on the sale of any part of the property let to the company

Question 4

The couple are high risk investors with a significant cash holding. Describe the
tax advantages that apply to:
i) An EIS

Answer 4

EIS
 Income tax relief at 30% of amount invested to reduce income tax bill
 Up to total income tax paid
 Clawed back if not held for 3 years
 Maximum £1m (£2m for knowledge intensive companies)
 Although can carry back to previous tax year
 To maximise relief
 No CGT on share gains / on death
 If held for 3 years
 Can defer CGT liability (reinvestment relief)
 Reinvest one year before / up to 3 years after disposal
 This can lead to an immediate CGT saving
 Losses on encashment can be offset against income or CGT
 100% IHT relief if shares held for 2 years on date of death
 This would save IHT on the estate at 40% on the amount invested

Question 5

The couple are high risk investors with a significant cash holding. Describe the
tax advantages that apply to:

ii) A SEIS

Answer 5

SEIS
 Income tax relief at 50% of amount invested to reduce income tax bill
 Up to total income tax paid
 Maximum £100,000
 Although can carry back to previous tax year
 To maximise relief
 If held for 3 years
 Can defer CGT liability (reinvestment relief)
o 50% reinvested gain is exempt from CGT
o 50% deferred
 Reinvest one year before / up to 3 years after disposal
 This can be an immediate CGT saving
 Losses on encashment can be offset against income or CGT
 Otherwise CGT free after held for 3 years
 100% IHT relief if shares held for 2 years on date of death
 This would save IHT on the estate at 40% on the amount invested

Question 6

The couple are high risk investors with a significant cash holding. Describe the
tax advantages that apply to:

iii) A VCT

Answer 6

VCT
 Income tax relief at 30% of amount invested to reduce income tax bill
 Up to total income tax paid
 Up to £200,000 per year
 But, cannot carry back to previous tax year
 Must be held for 5 years of clawed back
 No tax on dividends
- No CGT on share gains / on death
 No minimum hold period for CGT
 But, no CGT deferral/reinvestment relief
 But, no IHT relief

Question 7

The couple are high risk investors with a significant cash holding. Describe the
tax advantages that apply to:

iv) AIM shares

Answer 7

AIM
 No income tax relief
 No CGT deferral
 100% IHT relief if shares held for 2 years on date of death
 This would save tax at 40% on amount invested

Question 8

Explain in detail how either Dan or Tara could use an Enterprise Investment Scheme to potentially mitigate their income tax liability and state the long-term benefits of using such a scheme.

(NB The same question could be asked in relation to an
SEIS – think about how you’d adapt your answer (the information you need is provided in the answer to the previous question))

Answer 8

 30% income tax relief on contributions
 Limited to total income tax paid in tax year
 Can carry back to previous tax year too
 Tax bill is £10,000, so invest up to £33,334 to mitigate
 Must be held for 3 years
 Otherwise tax relief clawed back
 Losses on encashment can also be set against income tax
 CGT deferral available via reinvestment relief
 Reinvest one year before / up to 3 years after disposal
 CGT free if held for 3 years
 Business relief available if held for 2 years and on death
 High risk investment suits ATR and they have sufficient capacity for loss
 Diversification / growth potential

Question 9

Dan and Tara have expressed an interest in commodities. Explain to Dan andTara the benefits and drawbacks of including commodities in their portfolio.

Answer 9

Benefits
 Spreads risk by adding diversification
 Low correlation with other assets e.g. equity and bonds
 Matches their high ATR
Drawbacks
 Prices can be volatile
 Short-term supply and demand issues
 Higher probability of sudden and unfavourable changes in commodity prices when compared to normal shares
 Markets are dominated by trading interests
 Political risk

Question 10

With regard to commodities, outline to Dan and Tara the methods they could use to get investment exposure.

Answer 10

 Invest in companies that produce commodities
 Invest in funds that invest in commodities
 Invest in exchange traded commodities

Question 11

Explain to Dan and Tara how an exchange traded commodity (ETC) works.

Answer 11

 It tracks the performance of an underlying commodity or basket of commodities, such as metals or livestock that can otherwise be difficult
to access
 It may directly track the performance of a given commodity
 Or it may track an index that is designed to measure the value of that commodity
 There will be a management fee
 Income tax on dividends
 CGT on gains
 Can be included in an ISA
 Usually offshore

Question 12

Explain to Dan and Tara how a range of exchange traded commodities may be a suitable investment for them. (NB Think about the downsides too prior to your exam – these are listed above)

Answer 12

 Offers wide diversification
 Potential for growth
 Liquid (especially when compared to direct investment), treated as share
 Low cost
 No stamp duty
 Known price
 Easy to monitor
 Different management styles
 Matches high ATR

Question 13

Explain briefly to Dan and Tara why having 90% of their investments in cash (or any named cash investment) may be unsuitable for the long-term financial
security.

Answer 13

 No potential for capital growth
 No protection from inflation
 Shortfall risk
 Not tax efficient as not in ISA
 Does not match higher ATR
 Lacks diversification

Question 14

Comment on the suitability of direct investment in commercial property for Dan
and Tara.

Answer 14

 Single asset – lacks diversification
 May move in different direction to main market – adds diversification
 Single geographical location – lacks diversification
 Potential for growth (property value) / inflation protection (rental
increases) over long term
 Rental income tends to be more secure than residential
 Growth typically takes place in steps as rent reviews take place after
specified periods
 Property cannot usually be split (you have to sell the whole thing)
 Market difficult to analyse
 In line with high ATR
 Cannot be placed in ISA wrapper (no tax benefits)
 Will be included in estate on death
 Sale and purchase is slow and costly

Question 15

Outline the alternatives for indirect investment in commercial property for Dan
and Tara.

Answer 15

 Shares in listed property companies
 Property unit trusts and investment trusts
 Property authorised investment funds (PAIFs)
 Insurance company property funds
 REITS

Question 16

Explain to Dan and Tara how investing in shares of listed property companies would work and why it might be more suitable than direct investment.

Answer 16

 Buy shares in property companies
 Share prices affected by quality of management and borrowing as well as property values
 Share price rise and fall independently of property values, depending on supply and demand
 Affected by both market and specific risks
 Company pays corporation tax on capital gains and rental income
 May act like professional landlord (secure income)
 May be a construction company (more volatile)
 Potential to receive dividends and capital growth
 But not guaranteed
 More liquid way to invest
 Diversified over a number of properties spreading risk

Question 17

Explain to Dan and Tara how investing in shares of property unit trusts and investment trusts would work and why it might be more suitable than direct investment.

Answer 17

 UT can invest in shares of property companies or property itself
 They cannot borrow money as easily to invest
 Price of units linked to value of investments
 Fund may be gated in adverse market conditions – up to 6 months
 IT must invest primarily in shares and securities of property companies,
only small percentage allowed in property
 Can borrow so riskier than UT
 Share price moves independently of NAV in line with supply and
demand
 No tax on gains in fund
 Investor liable to CGT on disposal
 Can usually be ISA wrapped
 More liquid way to invest
 Diversified over a number of properties / property firms spreading risk

Question 18

Explain to Dan and Tara how investing in shares of property authorised investment funds (PAIFs) would work and why it might be more suitable than direct investment.

Answer 18

As above, for property authorised investment funds (PAIFs).
 OEIC that invests mainly in property (UT does not qualify)
 Point to taxation moves from fund to investor (as if invested directly in
property)
 Ring-fenced rental profits and property related income except from tax
in fund
 Other taxable income subject to corporation tax
 3 distributions – property income paid net 20% unless held in
ISA/pension, interest income paid gross, dividend income paid gross
 Conditions – 60% net income from exempt property investment
business, assets in property investment business must be at least 60%
of total assets, and shares must be widely held
 More liquid way to invest
 Diversified over a number of properties spreading risk

Question 19

Explain to Dan and Tara how investing in shares of insurance company property funds would work and why it might be more suitable than direct investment.

Answer 19

 Life funds direct holdings of commercial property
 Regular and single premium unit-linked contracts
 Value of units directly linked to value of property
 Fund cannot borrow
 Liquidity higher than direct property investment, though fund may be
gated in difficult market conditions
 Fund taxed at up to 20% on income and gains
 Diversified over a number of properties spreading risk

Question 20

Explain to Dan and Tara how investing in shares of real estate investment trusts (REITs) would work and why it might be more suitable than direct investment.

Answer 20

 A single company or group that owns and manages commercial or
residential property on behalf of shareholders (but not the letting of
owner-occupied buildings)
 Company must be UK resident, closed-ended and quoted on a
recognised stock exchange.
 If at least 75% of the company’s total gross profits come from property
letting, and interest on borrowing is at least 125% covered by rental
profits, then the company is exempt from corporation tax on property
letting portion of the business.
 Gains on sale of properties developed are taxable at 30% unless they
are held for at least three years from completion.
 At least 90% of rental profits must be paid out to investors within 12
months of the end of the accounting period. Such distributions consist
of two elements:
o A payment from the (corporation) tax-exempt element – this is
classed as property income and paid net of 20% tax which nontaxpayers
can reclaim (if held in ISA wrapper paid gross).
Higher and additional rate tax payers owe additional 20 and
25% of gross payment respectively.
o A dividend from the non-exempt element – this is classed as investment income, paid gross. Dividend allowance applies.
Thereafter taxed at 7.5, 32.5 or 38.1% depending on investor’s
tax status.
 Any capital gains are taxable in the usual way.
 More liquid way to invest
 Diversified over a number of properties spreading risk

Question 21

Explain to Dan and Tara how they could buy the commercial property via a Self-Invested Personal Pension (SIPP) instead and what the pros and cons of doing so would be. (This could also be a R&J question)

Answer 21

Transfer PP funds into a SIPP (workplace pension scheme)
 Means they are not using up their cash so can earmark more for school fees if required but still benefit from commercial property
 Use funds to purchase property outright
 Can borrow up to 50% of net assets if they are insufficient
 And/or consider mortgage
 Rental income would be paid to the SIPP
 Build up in the fund tax-free prior to retirement
 Provide an income stream at / during retirement
 Any growth in property price would also be free from tax
 Creditors cannot claim property couple face bankruptcy
 More of wealth outside estate / saves IHT
 Property is illiquid
 Lacks diversification – depending on cost of property may represent a significant holding in the SIPP
 At retirement, property needs to be sold if need a lump sum, e.g. PCLS
 Void periods
 May not be a good time to encash PP fund to make purchase

Question 22

Outline to the couple what would happen to their ISAs on death and how this would differ if they were married.

Answer 22

On death, ISA becomes deceased’s ‘continuing ISA’
 Cannot add further funds
 Tax free until earlier of estate being administered, the ISA is closed or 3 years from death
 Because they are not married, they cannot take advantage of the additional permitted subscription
 If they were married, the surviving partner could invest the higher of the value of the continuing ISA on death or on the date when the ISA wrapped investments are passed on to them as an ‘additional
permitted subscription’
 This protects the ISA wrapper
 And is in addition to the surviving partner’s own ISA allowance
 The surviving partner must register the APS with a provider
 They can transfer the holdings ‘in specie’
 Or they can sell the holdings and transfer cash to an ISA up to the value of the APS
 APS can be used the later of up to 3 years from date of death
 Or up to 180 days after estate is wound up

Question 23

Outline six benefits to Dan and Tara of using a discretionary fund manager in
relation to the placing and ongoing monitoring of their house sale proceeds.

Answer 23

 Professional expertise, bespoke investment and rebalancing
 Reduced personal involvement
 Access to larger range of investments
 Automatic use of tax allowances
 Potential for improved returns
 Reporting and tax statements provided

Question 24

Explain to Dan and Tara, in brief, the features of a platform.

Answer 24

The core purpose of a platform is to offer access to a wide range of investment funds or collective investments
 Different platforms offer access to different types of collective investments
 Open architecture platforms tend to offer unfettered access to OEICs, investment trusts and ETFs
 The wrappers can include ISAs, shares and other investments
 The investor’s holdings are all shown in a single account
 Which is usually accessed online
 Which enables investors to view their total assets and asset allocations
 And the up to date value of their investments in one place

Question 25

Explain to Dan and Tara the benefits of holding their investments on a platform

Answer 25

 Ease of administration / online access  Low charges  Access to a range of tax wrappers  Wide fund choice / ease of switching / rebalancing  Access to specialist funds / DIMs/ETFs / model portfolios / individual shares  Access to platform research / fund factsheets  Cash account available  Tax reporting / CGT  Bed and ISA  In specie transfers  Facilitates adviser charging

Question 26

Outline the process you would follow to enable you to review the performance of Dan and Tara’s investments / PP.

Answer 26

```  Letter of authority / obtain details  Confirm date of purchase  Confirm base costs / further investments / withdrawals / switches  Identify reinvested income  Calculate gain  Assess asset allocation  Identify suitable benchmark  Compare against benchmark  Review charges  Compare to risk-free return  Review risk rating on fund (volatility)  Assess funds against ATR and capacity for loss ```

Question 27

Comment on the suitability for Dan and Tara’s £150,000 each on deposit (NB This question could also relate to NS&I premium bonds (these might be worth keeping as tax-free winnings and easy access (they still need some money in cash) or NS&I income bonds – remember NS&I not impacted by FSCS limit)

Answer 27

Interest will be low (instant access being lowest of all)  Meaning there is limited opportunity for growth  Meaning there is little protection from inflation  Meaning the real value of the proceeds will start to fall  Both ATRs are high  A large cash holding is not in line with this  It does not benefit from favourable tax treatment and will be included in the estate on death  However, easy access and the couple have said they intend to invest the funds soon  Safe as covered by FSCS temporary high balance rules

Question 28

In relation to investments in general / commodities / commercial property, comment on the advantages and disadvantages for Dan and Tara of direct investment.

Answer 28

Advantages  May enjoy following individual firms  Optimal diversification 20 stocks  Match ATR  Low costs on switching investment managers  Tailored portfolio  Easier to exclude / include specific holdings for ethical reasons  Greater cost transparency  Use CGT annual exempt amount  Economy of scale and lower ongoing charges for large portfolios Disadvantages  High volatility as fewer holdings  Smaller portfolios may involve higher costs  Greater involvement by investment manager adds to costs  Results more variable  CGT may be incurred more often  Greater admin  VAT charged on management fees – no tax relief

Question 29

In relation to investments in general / commodities / commercial property, comment on the advantages and disadvantages for Dan and Tara of indirect investment.

Answer 29

``` Advantages  Wide choice of funds  Inbuilt diversification  Access to managed funds / different investment styles  Access to specialist funds  No tax on gains within the fund  No VAT on annual charges in fund  No stamp duty reserve tax ``` Disadvantages  Additional fees  Bid-offer spread when changing funds, initial charge  Minimal investor involvement  May be costlier to change investment manager

Question 30

Outline the key factors that an adviser should consider when recommending a suitable strategy for Dan and Tara’s large cash holding.

Answer 30

```  Objectives  Diversification  Timescale  Emergency fund  Ethical concerns / ESG  ATR  Performance and charges  Willingness to use trusts  Use of tax wrappers and allowances  What they want to happen on 1st death  Ongoing reviews ```

Question 31

Comment on the investment risk in relation to Dan and Tara’s shareholdings in their own business.

Answer 31

 Unquoted shares are very illiquid  Articles may place restriction on selling  If business becomes insolvent, dividends cease and shareholding loses capital value  Tax benefits (e.g. business asset disposal and business relief) can be removed  Overtime, their business may build up value which could lead to a lack of diversification  A single shareholding is very high risk

Question 32

Comment on the tax treatment of dividends and of disposal of the business during Dan and Tara’s lifetime.

Answer 32

 If dividends taken on top of current salary, basic rate of 7.5% payable above the remaining dividend allowance  Taking dividends rather than more salary saves NI for employer and employee  But dividends do not count as relevant earnings for pension purposes  CGT annual exempt amount can be used to reduce gain on sale of shares during lifetime  Shares should qualify for business asset disposal relief once they have held for 2 years as both Dan and Tara own more than 5% each  Tax rate of 10% then applied on lifetime gain up to £1m

Question 33

Explain how they Dan and Tara could maintain business relief following the sale of their business to mitigate future IHT.

Answer 33

 Providing asset held for over 2 years  Is a qualifying trading asset  IHT free, saving 40% if falls in excess of NRB  Can rollover sale proceeds into other assets qualifying for business relief, e.g. EIS or AIM shares  Must re-invest within 3 years  Will retain business relief  BR qualifying asset can then be passed to the surviving partner / twins on death

Question 34

State the factors an adviser should consider when constructing an investment portfolio for the twins’ school fees

Answer 34

 Initial 9-year timescale, but then ongoing for at least 7 years  Cost of school fees  Allowing for inflation / expectations of future inflation  And whether university fees need to be included  The degree to which the proceeds of the house sale cover this already  Expected investment return on proceeds from house sale  Any shortfall  Other assets that could make up the difference  Whether there’s a need to save regularly from income to make up the difference  High ATR / capacity for loss  Growth required / growth assumptions  Pound cost averaging for any regular saving element  Tax efficiency – use of ISA allowances  Asset allocation – to match timescales  Diversification – asset classes, geography etc.  Need for life and health insurances  Ongoing reviews

Question 35

Explain how ISAs could be suitable investment vehicles for Dan and Tara to build-up a fund to meet the twins’ school fees.

Answer 35

 No income tax or CGT  Can invest £20,000 of existing lump sum each year  Remaining funds can be drip fed overtime using CGT annual exempt amount if placed in other collectives in the mean time  Wide range of investment options to match ATR and term (ranging from 9 years up to around 20 if university fees also to be covered)  Can switch funds  Can combine both cash and S&S holdings to match term  Can transfer providers  Can withdraw funds when needed with no penalties  Can make both lump sum and regular contributions  Wide choice of providers  Retain control of funds and can pay fees when needed  However, no APS as unmarried so loss of tax-free status on death

Question 36

Outline the benefits to Dan and Tara of using a diversified investment strategy to meet the twin’s school fees.

Answer 36

```  Potential for growth  Protection against inflation  Non-correlation of assets  Reduces risk / lower volatility  Rebalance  Match ATR  Avoids over-exposure to single asset class ```

Question 37

Explain to Dan and Tara why their UK Equity Income funds could be suitable to provide for school fees

Answer 37

 Growth potential / inflation protection  High yield / increasing dividends  Exposure to large UK companies / diversified  Dividend income can be reinvested  Tax-free (to the extent they are ISA wrapped)  No currency risk  No political risk  Long-term timescale  Actively managed  Liquid

Question 38

Explain to Dan and Tara why an investment bond could be a suitable investment vehicle to build up a fund for the school fees of the twins. (I do think an ISA plus collectives is more likely, but just in case)

Answer 38

 Dan and Tara are basic rate tax papers  Fund deemed to pay tax at basic rate  No further liability to Dan and Tara on encashment if they remain basic rate tax payers  If gain pushes them over, they benefit from personal savings allowance and top slicing which could still result in zero tax  5% tax-deferred withdrawals could be used to fund fees  Wide choice of funds  Wide choice of providers  Can switch funds  Match ATR and timescales  But, cannot use CGT annual exempt amount  If they become higher rate tax papers, tax charge is 20%

Question 39

Explain to Dan and Tara the downsides of commercial property funds.

Answer 39

```  Can be illiquid / gated  Pricing issues  Lack of asset class diversification  If UK fund, lack of geographical diversification  High ongoing charges  Forced sales reduce value of fund  Cash holdings dilute returns  Property value is subjective  Tax rules may change  May not match ATR ```