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Value-added facts

In the wake of CP121, last week I started to look at key taxation issues underlying commission rebates, cashbacks and discounts. I started with a general overview of the taxation of commission received by IFAs and rebated to clients.

Still maintaining a general outlook, we now need to consider the position of cashbacks and discounts for both the IFA and the client.

A cashback received by an ordinary retail customer is not taxable. There will also be no tax implications for the IFA in respect of any cashback received by the retail customer direct from the product provider.

What is the position if the client pays a discounted amount in respect of his or her contract with the provider? A reduced payment by the client, without the IFA having any entitlement to the commission or receiving it, does not result in the amount of the discount being taxed on the IFA. The position will normally cover lower-scale commission and higher unit allocations.

This kind of arrangement is clearly prevalent now and likely to become more so under any defined payment system of remuneration for IFAs. Under such a system, once commission is paid up to the agreed amount of fee, the IFA will have no entitlement to any further amount paid directly by the client or indirectly through commission. In such circumstances, the value secured in the financial product can be increased – an effective discount as the client will get more for his money than he ordinarily would. For the ordinary retail customer receiving the benefit of the discount, no amount is taxable.

If the financial product involved is a qualifying life insurance policy, a non-qualifying policy or a personal pension or retirement annuity, the discounted premium counts for the qualifying policy and chargeable event rules and for calculating tax relief on personal pension and retirement annuity contributions.

Where, perhaps as a result of the IFA remuneration cap implicit in a defined payment system, extra value is added to a product, perhaps as an additional allocation of bonus units, there are no tax implications for clients or IFAs. The premiums actually paid are taken into account for the qualifying policy and chargeable event rules and for personal pension and retirement annuity tax relief purposes.

Having given an overview of the taxation position on rebates, discounts, cashbacks and added value, I would like to look at these issues in a little more detail.

It is understood to be the Inland Revenue&#39s view that the following arrangements may apply to commission that is used for the client&#39s benefit. Commission may be:

•Actually received by the client.

•Netted off, meaning that the client&#39s obligation to pay the full purchase price is set off against an entitlement to commission so that only the net amount is paid.

• Invested, meaning that any commission due is used to secure additional benefits under the contract.

•Alternatively, a discounted purchase price is paid, meaning that the client&#39s obligation under the contract itself is to pay less than the full purchase price. Here, the client has no explicit entitlement to commission or a cashback.

For trail commission, only the first two are likely to apply.

Let us look first at the position of the IFA in detail. IFAs are normally assessed under Case I or Case II of Schedule D on trading profits in respect of any commission received. Case VI of Schedule D (which taxes any annual profits or gains not falling under any other case of Schedule D and not charged by virtue of any other schedule) will only be relevant where the profits are of a truly casual nature, which is most unlikely to be the case for an IFA.

For most IFAs, therefore, any commission received will be treated as a trading receipt and taxed accordingly. It is not, however, unusual for an IFA to enter into an agreement with the client – and perhaps the product provider – whereby commission is rebated to the client or reinvested on his behalf. As I have stated already, such arrangements may become even more prevalent in the future if the proposed defined payment system becomes a reality for IFAs.

Where such rebating or reinvestment takes place, commission payable on a contract would usually be assessed to tax on the IFA provided the IFA is entitled to commission in the ordinary course of his trade.

Anecdotal evidence suggests that many IFAs already operate a kind of defined payment system by agreeing in their terms of business a fee with the client but subject to the proviso that, should any commission-producing business be done, the commission earned by the IFA will be set against the fee up to the agreed amount. The IFA will then select a level of commission on any products arranged so that it does not exceed his agreed fee. The client in effect then benefits from any untaken surplus commission.

Next week, I will consider in depth the key tax issues connected with rebating, etc.

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