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Commission position

This week, I am going to continue with the topical themes of commission rebates, cashbacks and discounts. In my last article, I began to look at the taxation of commission to which the IFA is entitled. Generally, this commission would be taxable as a trading receipt regardless of how it is dealt with subsequent to the entitlement. I would like now to look at the position where commission to which the IFA is entitled is used to benefit the client. In all cases, I will first restrict my consideration to taxation of the IFA. I will consider deductibility later.

Where commission is received from a provider, it will be assessed on the IFA even if it is passed on to the client. For example, if commission is £5,000 and the IFA passes back £2,000 to the client, the IFA still has trading income of £5,000.

Where the IFA deducts commission from the gross investment received from a client and passes on the net amount to the provider, subsequently refunding part of the commission to the client, the amount of commission deducted will still be assessable on the IFA because of his entitlement. For example, where the client pays £10,000 to the IFA, of which £5,000 is passed to the provider and £5,000 represents commission, with £2,500 being rebated to the client, the IFA still has trading income of £5,000.

Where, under an agreement between provider and IFA, commission to which the IFA is entitled is paid direct to the client by the provider, the IFA is assessable on the commission. For example, where commission is £5,000 and an IFA authorises the provider to pay £2,500 to the client, the IFA still has trading income of £5,000.

The IFA is also assessable on all the commission where, under an agreement between client and IFA, the commission is rebated so that only the net amount to be contributed to the product is paid by the client. For example, an IFA agrees to rebate 50 per cent of commission to the client. The gross investment is £10,000 and commission is £5,000. The client pays £7,500, of which the IFA pays £5,000 to the provider and keeps £2,500. The IFA&#39s trading income is still £5,000.

Finally, where, under a mutual agreement between the IFA, client and provider, commission is added to the value of the policy, for example, by enhanced allocation of units, the full amount of the commission is assessable. For example, an IFA is entitled to £5,000 commission on an investment of £100,000 under which the unit allocation is 101 per cent and bid/offer spread 5 per cent. On day one, the contract is worth £96,000. The IFA agrees to forgo half his commission in return for the unit allocation being increased by 2.5 per cent. The investment value on day one is £98,500 but the IFA is still assessed on trading income of £5,000.

Where commission is passed on to the client or is otherwise forgone, perhaps as an inducement to enter into a transaction, but is assessed on the IFA as described above, the IFA may claim it as a deductible expense under section 74(1)(a) ICTA 1988 as being incurred “wholly and exclusively for the purposes of the trade”.

Commission may be received by an IFA for introducing a client to a supplier of goods or services, generally known as introducer&#39s commission. If such commission is not otherwise taxable under Case I or II of Schedule D and entitlement to it arises under an enforceable contract, it will be treated as a taxable receipt under Case VI Schedule D as a profit of a casual nature. Only wholly ex gratia receipts of commission will avoid liability by virtue of the absence of any contract underlying the arrangement.

In cases where commission is taxed under Case VI, it will be deductible for the IFA to the extent it is passed on to the client as a condition of them entering into the transaction or where for some other reason the payment is necessary to earn the commission.

An IFA may earn commission on goods or services bought by himself or his family. Strictly, commission earned in such a way is taxable under the ordinary rules of Case I or II. But, by concession, to the extent the commission does not exceed the maximum amount the IFA could reasonably have been expected to pass on to a client in an arm&#39s length transaction for the same purchase, such commission may be left out of account for tax purposes.

I will now look at the position of an IFA&#39s clients. It is important to note that SP 4/97 does not apply to trustees and the tax treatment of commission received by trustees will depend on the facts of each case.

The general position is that no income tax is assessable on the client if he or she is an ordinary retail customer, regardless of whether commission is received, netted off or invested. The expression “ordinary retail customer” is not defined but it is thought this would apply to most IFA clients.

This general position is quite clear but it is important to have regard to the special rules applying in respect of qualifying life policies, chargeable events and pension plans.

Where commission is received, netted off or invested, a qualifying life policy will not risk disqualification if the commission contract is separate from the contract of insurance. Were this not the case, commission received could be treated as a benefit of a capital nature not permitted under the qualifying policy rules or commission netted off would reduce the initial premium which could upset the qualifying status of the policy. For this purpose, the Inland Revenue does not treat two contracts as one. I will look at chargeable events and pension plans next week.

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