Section 10 - Indirect Investments Flashcards
Tax Wrappers
Three main stages to consider:
- How the initial investment is treated
- How the funds are taxed within the wrapper
- How the proceeds are taxed on the investor
Individual Savings Account (ISA)
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:
- Cash 16+
- Stocks & Shares 18+– including collectives
- Innovative finance 18+ – peer to peer loans and crowd bonds
- Help to Buy ISA – existing customers only
- Lifetime ISA – age 18-39 at outset, £4,000 limit, first home / retirement
- 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
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
- No further funds added
- 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:
- ISA benefits can be passed to spouse/civil partner via an additional ISA allowance (APS).
- 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
Child Trust Funds (CTF)
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)
Can transfer to Junior ISA
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
Types of CTF
Savings account
Accounts that invest in shares
Stakeholder accounts
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
UK Collectives
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 8.75%, 33.75%, 39.35%
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%
Offshore Collectives
Offshore funds generally set up in countries with little/no local taxation e.g., Channel Islands
IHT planning – excluded property for non-UK doms
Reporting Funds
Status granted if fund reports full details of income to HMRC
Investors told of their share of fund’s income to allow reporting on self-assessment
No requirement for fund to distribute income
UK investors subject to income tax on share of fund’s income (regardless of whether it is distributed)
Profit on encashment liable to CGT
Non-Reporting Funds
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
Reporting Fund vs Non-Reporting Fund
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
Offshore Funds and Tax
Offshore equity funds - dividends normally subject to withholding tax (non- reclaimable)
Fixed interest - Eurobonds and exempt gilts pay income gross
Special Purpose Vehicles
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
Shares in Listed Property Companies
More liquid than investing directly in property
Investment is diversified over a number of properties
Property shares move more rapidly than property market
Real Estate Investment Trusts (REITs)
Investment companies that enable investors to put money into residential and commercial property markets by investing in them
REIT 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
Insurance Company Property Funds
Value of units linked directly to underlying properties
No gearing
Higher liquidity than direct property investment, but notice periods can apply
Property Unit Trusts, OEICs and Investment Companies
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)
Enterprise Investment Scheme (EIS)
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:
- Gross assets not exceeding £15m prior to investment (£16m after)
- Qualifying trade
- Permanent establishment in UK although no need to trade in or be resident in UK
- Unlisted when EIS shares issued
- Fewer than 250 full time employees (500 for knowledge-intensive firms)
- No more than £5m raised under EIS (£10m for knowledge-intensive firms)
Excluded qualifying trades include:
- Dealing in land, commodities, futures, shares or securities
- Banking and insurance
- Property development
- Legal or accountancy services
- Forestry and timber production
- Companies benefiting from renewables obligation certificates (ROCs)
- and/or the renewable heat incentive (RHI)
Withdrawal of relief:
- If shares disposed of within 3 years
- If company ceases to be qualifying
CGT deferral:
- Defer CGT by reinvesting gain into shares that qualify under EIS
- Maximum potential tax relief 58% (30% income tax and up to 28% CGT)
Tax planning:
- High risk, illiquid
- Can offset losses against income tax or CGT
Seed Enterprise Investment Scheme (SEIS)
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)
Venture Capital Trusts (VCTs)
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:
- Not a close company
- Must be listed on stock exchange
- Income derived wholly/mainly from shares or securities
- 80% of investment by value in qualifying unlisted trading companies
- No more than 15% in one company
- At least 10% of qualifying holdings in new ordinary shares
- At least 70% of investments by value in qualifying holdings must be in new ordinary shares
Qualifying conditions:
- Less than 250 employees (500 for knowledge-intensive firms)
- Less than £15m of gross assets before investment and £16m after investment
- 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:
- 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
- Cap on investment into a firm from EISs/SEISs and VCTs of £12m (£20m KIFs)
- EISs and VCTs not able to fund buyouts including management buy-outs to VCT funds raised prior to 2012 and VCT non-qualifying holdings
Social enterprises
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
UK Life Assurance Policies
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
UK Life Assurance Policies - Taxation
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
Qualifying policies are more favourable as only gains within first 10 years are taxable
All gains from non-qualifying policies are taxable
UK Life Assurance Policies - Chargeable Events
Death (if it 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)
UK Life Assurance Policies - 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
Calculating Chargeable Gain
Maturity/Surrender:
- Amount paid out (including any capital payments) less premiums paid (including any previous chargeable gains)
Death:
- Surrender value before death (plus any capital payments) less premiums paid (including any previous chargeable events)
Assignment:
- Price received (plus capital payments) less premiums paid (including previous chargeable gains)
If assignment is between connected persons, then market value used
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
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
Termination of Policy
Terminated by death, maturity or full surrender
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 higher – 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:
- Onshore policies, full surrender: divide gain by full number of policy years since outset
- Onshore policies, partial surrender: divide gain by full number of policy years since last chargeable event
-Offshore policies (pre-6 April 2013): divide gain by full number of policy years since outset
- 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
Administering Tax
Life office issues certificate to policyholder on chargeable event
Certificate enables completion of self-assessment
Chargeable Gains Under Trust (Where UK Resident Settlor/Trustees)
Taxation of gain depends on residence of trust creator and trustees
If person who created trust is alive and UK resident before chargeable event, then gain treated as part of income, top-slicing available, can reclaim tax from trustees
If person who created trust was dead or non-UK resident before chargeable event and one or more trustee UK resident, then trustees liable (45% trust rate so 25% liability onshore bond with 20% tax credit, 45% offshore bond no tax credit)
If trustees not UK resident, any beneficiary receiving a benefit under the trust from the gain is liable
Possible to avoid trust’s liability - replace UK trustees with foreign trustees prior to chargeable event - beneficiaries then liable at own rates, but no top slicing and no reclaim of tax credit on UK policy
Alternatively, assign policy to beneficiary before chargeable event, beneficiary can then encash and tax is chargeable at their rates with top-slicing relief
Assignment of a policy is not a chargeable event
Bare/Absolute trust for minors - beneficiary liable to income tax on gains arising from policies held in trust
Settlements legislation - if either or both of child’s parents are settlors of bare trust then potentially liable to income tax on gains from a life assurance policy
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
Offshore Life Assurance Policies
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 Life Assurance Policies
Onshore:
- Higher rate taxpayers - 20% on net return of fund
- Additional rate taxpayers - 25% on net return of fund
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
Overseas Life Assurance Business (OLAB)
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
Personal Portfolio Bonds
Personal portfolio bonds unattractive for UK investors
Penal tax which effectively taxes policyholder as if investments yielding 15% compound
Friendly Society Policies
Able to sell exempt policies
Qualifying policies with limited premiums
Funds are free of UK tax
Limits - £270pa/£25pm
Under 18s = baby bonds
Structured products
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
Pensions
Registered Pension Scheme Privileges:
- Tax relief on input
- No CGT on gains or investment income within fund
- 25% of fund tax-free on crystallisation
- Tax-free death benefits before age 75 (within limits)
Contributions:
- Employed and self-employed - tax relief on contributions up to 100% of earnings
- Employer and employee contributions - up to annual allowance £40,000
- Subject to tapered annual allowance (min £4,000) for those with total income in excess of £240k (reduced by £1 for every £2)
- Low/no earnings - £3,600 per annum with basic tax relief
Tax Relief on Contributions:
- Net pay method - contributions deducted from pay before calculating tax
- Relief at source - contributions net of 20% tax (higher relief claimed from HMRC)
- 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:
- Any unused part of the annual allowance from previous 3 years – 2021/22, 2020/21 and 2019/20 for 2022/23 - can be carried forward and added to the current year’s allowance
- Pension Input Period - in line with tax year since 2017/18
Max Benefits
Lifetime limit £1.0731m
Max tax-free cash - 25% of fund
Retirement date - earliest age 55 (rising to 57 2028)
Death benefits before 75 - usually tax free up to lifetime allowance
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%
Annuities
Purchased Life Annuity (PLA):
- Capital content tax-free,
- Interest element treated as savings income and taxed @ 20%
- Capital content based on purchase price divided by number of year annuitant expected to live (mortality tables prescribed by HMRC)
Purchased Annuities Certain:
- Fixed term
- Capital content tax-free
- Interest element treated as savings income and tax and taxed @ 20%
- If annuity is paid to someone other than person who paid purchase price, then no tax-free capital content
Pension / Lifetime Annuity:
- Taxed in full as earned income
Deferred Annuity:
- Taxed as PLA when annuity taken
Annuities for Beneficiaries:
- Under a trust or will, taxed as full investment income, basic rate deducted at source
Cash Sum Payable Under Guaranteed Annuity:
- Tax-free
Structured Settlements:
- Annuity paid in settlement of claim for damages, paid without deduction of tax and not taxable in hands of recipient
Immediate Needs Annuity:
- 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
