Each month, these articles on finance knowledge will use sample exam questions from the ifs School of Finance’s Diploma for Financial Advisers (DipFA) qualification to explore topics relevant to advisers in their everyday jobs, even if already level four qualified. There will also be tips on study and assessment techniques.
We start off the series by looking at objective (multiplechoice) examinations. This type of test is a common feature of many UK financial ervices exams and is also used in qualifications relating to various other professions such as medicine and law.
Objective testing is used to assess the Financial Planning Principles unit of the DipFA which focuses on understanding the financial services industry and how markets operate. This month, we will look at a sample case study which is normally followed by 10 multiple questions. We will use one question from this set to explore the relevance of distributor status.
Read the question above, then read on.
1: If Arthur’s offshore fund has distributor status, which of the following will be a feature of the fund?
A: Dividends are paid net.
B: Dividends are tax-free.
C: The annual CGT exemption is available.
D: The fund must distribute 75 per cent of its net income.
Explanation and answer
Many UK investors invest money in offshore unit trusts and Oeics. These are usually located in tax-friendly jurisdictions such as the Isle of Man, Luxembourg, Jersey or Guernsey. Such funds may have no local taxes applied on their earnings but the treatment of both income and rolled-up gains, in the hands of the UK investor, will depend on whether the fund has distributor status.
The correct answer to this question is C as funds with distributor status are generally more attractive because of the generous exemptions and reliefs which go with CGT treatment.
The capital growth delivered by distributor status funds is taxed as capital gains tax, which is why they are more attractive to UK investors than funds with non-distributor status.
The gains, as well as the income, of non-distributor status funds are taxed at the investors’ higher rate of income tax which is higher than CGT and therefore normally less advantageous for the investor.
A and B can be ruled out as correct answers to this question as dividends in a distributor status fund are paid gross, not net. B is incorrect as
dividends are taxable.
Furthermore, D is also incorrect as distributor status is accorded to certain offshore funds by HM Revenue and Customs, provided:
- The fund pays out at least 85 per cent of its income to investors (and does not roll it up) and,
- It complies with certain investment limits.
This does not mean that UK investor should only consider overseas funds that have distributor status – many funds cannot achieve this statusbecause their investment strategies do not allow them to do so.
Where the investor can choose between two similar funds, however, one with distributor status and one without, this should be a serious consideration.
The EU savings directive (EUSD) on interest-bearing investments held overseas is also worth noting here. This directive seeks to ensure that
individuals resident in an EU member state who receive savings income from another member state are taxed in the member state in which they are resident for tax purposes. EUSD applies to certain over-seas funds that invest substantially into such interestbearing investments, so potential investors in such funds should ensure that they are familiar with the regime before investing. Many funds – both onshore and, in some
cases, offshore – can also be held in ISAs. In these cases, of course, neither gains nor distributions will be taxed.
A question of pensions
Arthur and Beryl, aged 60, are married and are both in good health. They are resident in the UK and will retire in the next few months. Arthur has been a further education college lecturer in economics for the past 25 years and Beryl has worked part-time as a secretary in a local estate agency.
Arthur will get a pension of £14,000 a year and a tax-free lump sum of £42,000. Beryl only has a small personal pension fund of £17,800. Beryl wants some guidance regarding what she can do with her fund as she believes it may be taken wholly as a lump sum. Arthur has also been interested in the world of finance and is considering his investment options.
He has an Isle of Man bank account holding £30,000 and some offshore Oeic funds which he believes have distributor status and are valued at about £22,000. He is unsure about the benefits of offshore investment and seeks your guidance on the taxation aspects of such investments.
In addition, he is wondering whether to invest in the stockmarket directly with a small proportion of his savings. Arthur has sought advice from Martin, an IFA, regarding derivatives, including futures, options and swaps and what other types of investments are available on the London Stock Exchange and, in particular, listed debt
Tips for attempting an objective examination
As anyone who has completed this type of exam in the recent past will attest, passing this type of exam involves much more than simply “cramming” a single learning manual and acquiring knowledge.
Such tests have a strong focus on the ability to apply knowledge in the real world meaning that students need to understand the subjects
- Read every word carefully – a single word can change the whole meaning of a question, paying close attention to any word in bold
- Be aware of any negatives in either the stem (question) or the options (answers). If you find one, read even more carefully
- Always read all four options before choosing. While question writers don’t deliberately try to trick candidates, they are required to offer distracters (wrong answers) that are plausible
- Check your time periodically throughout the examination so you always know how much time you have left
- Allocate yourself at least 15 minutes at the end of the exam to ensure that you have answered every question and to check any answers you are unsure about