Last week, I started to look at possible investments for existing funded unapproved retirement benefit schemes. Given the protected status that these schemes can secure by accepting no further contributions after A-Day, many may well feel this to be valuable. Tax-free payment of lump-sum benefits and inheritance tax freedom on the payment of benefits on death is not to be sneezed at, is it?
I gave a brief overview last week of the tax position. This week, I am going to look at three well-used types of retail investment wrapper, namely, authorised collectives, UK insurance policies and offshore insurance policies.
The major tax attraction of collectives is, of course, tax freedom on capital gains made by the fund manager on disposals and the resulting accumulation of a worthwhile taper relief period for the investor. In the context of a trust subject to the 40 per cent rate applicable to trusts on capital gains, taper relief can reduce this rate in effect to 24 per cent.
Subject to there not being any unnecessary or unacceptable double charging, a fund of funds or manager of managers structure with an outer shell will give the benefit of open architecture but with the protection of an identifiable legal structure within which the funds can be managed without triggering investor disposals. The outer shell can be either a unit trust or an Oeic.
It is important to remember, however, that if there is no separate outer shell, the necessary CGT protection and accrual of a long taper period (despite disposals and acquisitions within the fund) will not take place.
Disposals by an investor of their interest in one sub-fund of an Oeic (each of which is usually constituted as a separate company) so as to, say, invest in another sub-fund, will normally be a chargeable disposal.
The price to pay for the protection of a legal outer shell is that the investor gives up control over fund switching to the manager of the fund of funds or manager of managers. Many – especially non-investment specialists who do not have access to specialist advice – would consider this a reasonable price to pay for the CGT benefits.
Where, in the course of investment management or asset rebalancing, disposals attributed to the investor (the trustees) do take place, it may be possible for the annual CGT exemption to be used to rebase the investment with no tax cost. This will have an upward effect on the deductible acquisition cost and a corresponding downward effect on the chargeable gain.
If reinvestment is to take place to focus on long-term growth in a tax-hospitable environment, any gains on realisation to facilitate this type of investment need to be considered. The other side of the coin is the tax treatment of income.
All dividends received, even if reinvested, will be taxed on the trustees of the Furbs at the basic rate (with the 10 per cent tax credit satisfying this liability) up to A-Day and 32.5 per cent (with a 10 per cent tax credit) thereafter. Interest will be taxed at 20 per cent up to A-Day and at 40 per cent thereafter.
The most obvious alternative to the collective structure is the insurance structure. This will be more attractive in respect of reinvested income but less so in respect of capital gains, generally speaking.
The UK life fund will bear tax on gains and income at 20 per cent. Dividends received will not be subject to further tax and indexation allowance will be available in respect of any capital gains.
The Inland Revenue has confirmed that the fact that the UK life fund bears tax will mean that the gains and income will be brought into charge to tax so no tax will be due on benefits paid out from the Furbs into which no further contributions are paid post A-Day. However, any chargeable event gains when the bond is encashed by the trustees would be subject to tax on the employer (as the person that established the trust) with no tax credit. However, the employer could reclaim this tax from the trust.
Another possibly more suitable investment to consider may be a non-UK insurance policy, that is, an offshore bond. There will be no tax on growth inside the structure and realised gains will, on the face of it – but subject to what is said below – be assessed under the provisions of section 547 ICTA 1988 on the person who created the trust – the employer company. This would mean that gains will be assessed not on the trustees but the company at its appropriate rate – 0, 10, 19, 23.75, 30 or 32.75 per cent. The company could reclaim this tax from the trust.
The question is whether this payment of tax by the company on realised gains is sufficient to satisfy the condition for the gains/income under the Furbs to have been brought into charge to tax. This is, of course, essential if the exit charge on payment of a lump sum to the member is to be avoided.
Correspondence with the Revenue has indicated that this would not be the case. However, it does seem that the charge to tax on the company can be avoided as the section 547 chargeable event charge is only applied to the extent that the gain is not otherwise made subject to tax (section 547(2)).
If the gain is realised to make a payment to the employee/member in the same tax year, as there would be a tax charge on payment to the member, a double charge is avoided. The charge would be made, in effect, on the member.
This does mean that, in most cases, a 40 per cent income tax charge would arise on the amount paid to the member less the amount taxed on the member when the contribution was made to the Furbs. In other words, the tax liability on the growth is shifted from the company to the member because the tax charge on the member takes priority over that on the employer.
It must be borne in mind that if a gain is made and the payment out to the employee is not made in the same tax year, the section 547(2) set-off would not appear to apply and the tax charge on the gain will need to be paid. A reclaim should be possible when the benefit is paid to the employee by the fund trustees.
These are the investments that will no doubt be considered if the IHT benefits given by the Furbs are to be maintained. In considering these options, advisers will no doubt take into account the alternative – removing funds from the Furbs. I will look at this next week.