At the upper end of the retail investment market, you cannot fail to have noticed the increased attention paid to wraps and platforms. Advisers will be focusing on the utility that the wrap or platform offers as a single place to buy and manage investments and, increasingly, implement broader investment and financial planning strategies.
Properly executed, there is no denying the benefit that aggregation can deliver. Some big advisers will have their own platform or have a share in the ownership of one. Those who develop and offer platforms will have an eye to the long-term quality revenue that the platform can deliver. In effect, the platform provider will be looking to grab some of the value from the chain linking the consumer to the product provider.
Some product providers have clearly identified this intrusion on their space and sought to offer their own wrap, especially to those advisers or distributors who have been their gateway to investing clients.
Whatever the relationship between the adviser, client and wrap or platform, it is generally accepted that to be in a position to tax-manage the selected portfolio, it is essential to have access to a wide range of product wrappers. At the super-charged end of the spectrum of tax-advantaged wrappers are registered pension schemes and then Isas.
It is essential that pensions are seen as tax-effective wrappers for which the investor has to accept certain constraints in respect of access to and the form of benefits that can be taken.
After pensions and Isas come UK collectives and insurance products or bonds. In connection with the choice of insurance wrappers to surround portfolios of funds to be bought on a platform, the offshore bond is almost routinely available. Its tax-deferment qualities are well known, as are the main differences between the taxation of a bond provided by a UK insurer and its offshore equivalent.
But when it comes to collective investments that are available unwrapped by insurance, Isas or pension shells, very little airtime seems to be given to the offshore versions and even less to the relative merits of distributor and nondistributor versions of offshore funds.
To most UK investors, offshore funds represent the non-UK version of unit trusts and Oeics.
The majority of offshore funds are constructed as corporate entities. The corporate structure for a common investment fund or mutual fund is the standard outside the UK. Funds therefore typically issue shares to investors. In many cases, funds will offer different classes of shares to represent different investment areas, for example, one class for Far East growth stocks, another for UK smaller companies and so on.
It is this non-UK prevalence of corporate structures that has been one of the driving forces behind the development of the UK Oeic. Until the end of December 1983, many funds provided opportunities to roll up income and gains. This deferred the tax charge for the UK investor and, because of the structure, ensured that gains, when eventually taken from the fund, would be subject to capital gains tax.
With a wide difference in income tax and capital gains tax rates, there was a substantial amount of interest and activity connected with these funds.
There was some consideration given at that time to applying general anti-avoidance legislation to the funds (section 478 ICTA 1970, now section 739 ICTA 1988) to assess the income arising inside the fund structure on a yearby-year basis. However, specific legislation was eventually decided on which resulted in the offshore funds legislation in sections 757-764 ICTA 1988. The broad aim of this legislation is:
– To classify funds as either qualifying or non-qualifying.
– To deny non-qualifying funds capital gains tax treatment and to assess all gains under such funds to income tax.
Offshore funds can consequently be broken down into two types – distributor funds and non-distributor funds. For tax purposes, the distinction is qualifying and non-qualifying funds respectively.
Non-distributor funds are frequently called roll-up funds. The critical difference, unsurprisingly, is that at least 85 per cent of the distributor fund’s income must be distributed to its investors if the status is to be maintained. The test is run on a yearly basis.
Broadly speaking, satisfaction of the distribution test means that income will be assessed on the UK resident as it arises and capital gains will be eligible for indexation allowance up to April 5, 1998. Thereafter, taper relief and the annual exemption can be used.
Funds which do not by accident or design satisfy the distribution test – and remember, this is a yearly test – will be classified as non-distributor funds. These funds are also known as roll-up funds to reflect the fact that during their lifetime and until any partial or whole encashment or gift is made, there is no taxable income or gain to be assessed on the investor.
However, when a partial or whole encashment or gift is made, the gain is calculated using capital gains tax principles but without the benefit of indexation allowance (only available up to April 5, 1998 anyway), taper relief or the annual exemption.
These non-distributor funds can, however, be useful mediumto longterm tax-deferment vehicles. More on this next week.