For professional advisers only Quarter

Transcription

1 For professional advisers only Quarter eye Hot topics Tax efficient decumulation the way forward Collective investments and capital gains tax Charging up Why some females got an unexpected early Christmas present A DIM trio for VAT Chargeable transfers why you should think outside the band 40% 10% = 36%

2 Technical Services Update Every individual within our Technical Services Team understands that you have specific needs; you want the right technical information for you, delivered in the right way, at the right time whether it s taxation, trusts, estate planning or pensions. In a market where provider technical support is being withdrawn from advisers, Canada Life have enhanced and re-aligned their support proposition, which sits under a distinctive brand, ican, an initiative that unites our Technical Services offering and reflects our commitment to you. Karen Stacey Marketing and Technical Support Manager 2

3 Contents Welcome 5 Hot topics 6 Tax efficient decumulation the way forward 8 Collective investments and capital gains tax 11 Charging up 16 Why some females got an unexpected early Christmas present 17 A DIM trio for VAT 18 Chargeable transfers why you should think outside the band 20 40% 10% = 36% 23 Technical Services Empowering Professional Advisers 3

4 Great service makes you happy At Canada Life having the highest service levels mean everything to us, because it s something you need and deserve. To encourage ever higher standards we look to the prestigious Financial Adviser Service Awards as a way of recognising the commitment and expertise of the teams who support you. Thank you to everyone who voted for us Technical Services Empowering Professional Advisers Canada Life Limited, registered in England no Registered office Canada Life Place, Potters Bar, Hertfordshire EN6 5BA. Tel: Fax: Canada Life International Limited, Canada Life House, Alexandra Road, Castletown, Isle of Man IM9 1TG Tel: +44 (0) Fax: +44 (0) Registered in the Isle of Man no Member of the Association of International Life Offices. Canada Life group consists of Canada Life Limited, Canada Life Asset Management Limited (both authorised and regulated by the Financial Services Authority), Canada Life International Limited and CLI Institutional Limited (Isle of Man registered companies authorised and regulated by the Isle of Man Insurance and Pensions Authority). All promotional material produced is approved by Canada Life Limited. MKT R

5 Welcome Jeremy Pearson Technical Support Manager Welcome to the latest edition of Technical Eye, our regular bulletin about technical issues affecting financial services. The biggest challenge with this edition has been what to call it. The obvious (to my mind) title of Winter 2013 seeming to throw people into confusion as to whether it was at the start or the end the year. So as you can see, we settled on Quarter This has been an eventful year, with royal celebrations and gold medal winning efforts. It also marked the silver jubilee of our offshore arm, Canada Life International Limited. They have now been trading successfully in an offshore environment for 25 years and not many other offshore life companies can say that. And this is the last edition of Technical Eye before we embark into the brave new world of RDR and I m sure it will be a tempest. So we feature the position as regards adviser charging and estate planning. This caused us many sleepless nights until we managed to resolve the complexities of how to facilitate adviser charges under our packaged products. We had to ensure that none of the tax advantages were corrupted by our desire to facilitate adviser charging as much as possible. We are confident that has now been achieved. But we start with a follow up to our article on decumulation in the last edition with a practical example. Whilst not all clients circumstances will allow them the freedom of choice with retirement income, if they do have it they can ensure it is very tax effective. Whilst it is true that Canada Life has been a strong proponent of investment bond products over the years both onshore and offshore we also have award-winning fund managers and collective investment funds. Because of this, we felt that it was worthwhile to have a comprehensive article about how collectives are taxed, in terms of capital gains. This is essential knowledge for all of us. We do love acronyms in this industry and a new one popped up this year: GE. This has been much bandied about recently as it stands for gender equalisation which arrived on 21 December, just in time for Christmas! A reflection of the changes that has brought is included in this edition. We have seen growth in the popularity of recommending to clients that they link to a discretionary managed portfolio. That seems to be a common suggestion nowadays. However, there have been various tax issues surrounding discretionary fund managers and we recap those in this edition. One issue that always bemuses me from a purely technical point of view, is why every non-discounted discretionary trust that we see is for 325,000 or less. Although some enlightened advisers recommend investing 331,000. I appreciate that committing more to a discretionary trust and paying IHT up front is off-putting, but as the article in this edition shows, the overall results can be impressive. Our last article is about another event in 2012, the introduction of a reduced tax rate for charitable legacies...provided certain conditions are met. We look at the rules and also include various examples of when and when not the tax reduction will apply. But to end, I would like to mention where we start this edition. It is a new section which has been suggested by our readers. This year especially, there have been many proposed changes and consultations announced by the UK Government ( the Government ). It is easy to lose track on all these issues, so we have introduced a new hot topics section so that you know where we are on all these. I hope you enjoy this edition and find it a useful point of reference in your day-to-day business. Please let us know if that is the case. All feedback is gratefully received at ican@canadalife.co.uk. We also have various briefing notes and further information in the Technical Zone on the Canada Life IFAZone or visit for further updates. This is available to registered professional advisers. 5

6 Autumn statement This took place on Wednesday, 5 December 2012 and the timing meant that we could not cover any announcements in this edition of Technical Eye. But please contact your account manager for details as we have produced a separate summary of the Chancellor s announcements. Pensions: How do we make saving into a pension more appealing let savers get access to their funds? So now we have heard the Chancellor s autumn statement and yet again it is bad news on the pension front. The annual allowance is going to reduce by another 10,000 with a reduction in the lifetime allowance as well. But drawdown holders are going to be able to withdraw even more of their own money with a rise in the annual limit to 120% of a standard annuity rate. But sarcasm aside, with all the constant media criticism about how saving into a private pension is poor value what can the Chancellor do to make pensions more appealing in his Spring Budget? It is not a new idea but allowing savers to gain access to their Pension Commencement Lump Sum (tax free cash) without having to crystallise all their pension fund would appeal to many who feel locking away all their hardearned savings until retirement is a major turn off. Being able to help the kids with finding a deposit for a house or even having the funds to pay off the mortgage early would be popular and would not cost the Treasury any new money. If this encourages more people to save into a private pension then it has to be a worthwhile inducement. Wait a minute I hear you cry, saving into a pension should only be for retirement and this will only encourage undisciplined financial behaviour and make matters worse in the long term. My retort would be that if pensions are seen as so unattractive, then those mindful to save for retirement will only divert their retirement savings to ISAs for example, so what is the difference at least with a pension plan some of your savings are ring-fenced until retirement. GAAR and simplifying inheritance tax The consultations on the proposals for a General Anti-Abuse Rule (GAAR) and Simplifying Inheritance Tax (IHT) Charges on Trusts have now closed. The summary of responses, together with the reaction from the Government, still includes the farcical double reasonableness test originally proposed in the GAAR consultation (tax arrangements are abusive if they cannot reasonably be regarded as a reasonable course of 6 action) and has not been replaced by something rather more objective. Unfortunately, the proposals concerning the simplification of IHT periodic and exit charges did not include any consideration of simplifying the arithmetic involved but it remains to be seen whether this aspect will be changed as a result of the responses received to the consultation. Statutory residence test The original consultation on the proposals for a statutory residence test closed on 9 September The responses were such that the Government decided to postpone the originally planned implementation date from April 2012 to April A summary of responses was issued in June this year, including draft legislation for inclusion in the Finance Bill 2013, as well as further questions for consultation. This supplementary consultation has now closed and the Government published further draft legislation on 11 December This version will be subject to parliamentary scrutiny. Qualifying policies A qualifying policy generally sees gains exempt from income tax in the hands of the policyholder, unless, for example, the policy is surrendered within ten years (or three-quarters of the term, if shorter) after the policy was issued. Premiums payable into a qualifying policy have not previously been limited, allowing individuals to potentially claim unlimited relief from higher rates of income tax on the investment return. Changes were announced in this year s Budget after the Government became aware that the qualifying policy regime currently in place was being marketed as a means of avoiding tax charges. The consultation period closed on 6 September and a summary of proposals and next steps was published on 11 December However, from 6 April 2013 it is proposed that there will be an annual limit of 3,600 placed on the total premiums that an individual can pay into all qualifying policies they beneficially own, in any 12-month period. The limit will apply to any policy taken out after 20 March 2012 on premiums paid after 5 April 2013 throughout the life of a policy, so variable premium policies will be non-qualifying immediately if premiums payable will exceed 3,600 in any 12-month period.

7 This is a new section, designed to recap on technical issues currently under discussion or pending. By their very nature, proposals can change at any time so the information below, whilst correct at the time of writing, may have been superseded by events. If you would like to check the current position, just in case, please contact your account manager or ican@canadalife.co.uk Also, where the premium term is extended or the premium increased under a pre 21 March 2012 qualifying policy, it will be bought within the new rules. The profession has voiced concerns over including policies held before 21 March 2012 being brought within the new rules if an option is exercised. However, until the proposed changes are enacted into law, caution should be exercised when exercising an option to extend the premium paying term. Time apportionment relief The consultation period closed on 5 November 2012 and a summary of responses was published on 11 December Its aim is to ensure: a more consistent approach for policies issued by insurers inside and outside the UK, a more appropriate reduction to gains, the rules operate in conjunction with the new statutory definition of residence and changes to the basic calculation of chargeable event gains included in the Finance Act Time apportionment relief currently only reduces a chargeable event gain on policies, held by individuals, which are issued by a non-uk insurer. It allows the chargeable gain to be proportionately reduced by the amount of time the policyholder has been resident outside the UK. This means that no reduction is available for policies issued by UK insurers, even though individuals with such policies may also have periods of residence outside the UK. The proposals are: to extend the rules to allow time apportionment relief for individuals with policies issued by UK insurers, to base the relief on the residence history of the policy s beneficial owner. This includes limiting the time apportionment to the residency of the current owner only but allowing double taxation relief or unilateral credit relief to be claimed where tax has already been paid by the previous owner when they were non UK resident, to introduce a more complex calculation which takes into account when premiums are actually paid. The new definition is intended to include an anti-avoidance rule under which gains arising during temporary periods of residence outside the UK will be treated as income arising in the year of the policyholder s return to the UK. It is not clear if and how this new legalisation will affect existing offshore and onshore policyholders. However, assuming the proposals are enacted, companies may be required to include a new notice on chargeable event certificates informing policyholders that the gain shown on the certificate may need to be adjusted in certain situations. Which offshore company has held the most prestigious AKG rating for the past nine years? When it comes to offshore investments, we know your clients deserve to be with only the best-performing, strongest and most reputable companies. So we re delighted to remind you that we alone have held the 5-star AKG Annual Financial Strength Unit Linked Rating for the past nine years on the trot. Indeed, after 25 years of unrivalled strength we now have 7.8 billion* assets under administration, plus a cluster of awards that tell their own story. And with the added stability of being part of Great-West Lifeco, one of the top ten largest insurance organisations in the world, it s hard to imagine a more attractive option offshore. * As at 30 September For more details call us on +44(0) or visit 7

8 Tax efficient decumulation the way forward? Jeremy Pearson For the high net worth individual needing retirement income, the old days of filling your pension arrangements to bursting and taking a huge pension are past. This is mainly because people are now only allowed to accumulate pensions savings at a maximum of 50,000 each year (ignoring carry forward) with tax relief and when they come to decumulate, anything over a 1.5m pension fund suffers punitive taxation (unless protection is in place). Added to that, we currently have rock-bottom yields for drawdown and annuity rates; with the income produced being taxed at a marginal rate of up to 50%. It doesn t end there either, as any return of capital as a lump sum death benefit from drawdown, the lump sum will be taxed at 55% regardless of age. So we have the situation where, as unlikely as it sounds, a pension plan might not be the best way to provide retirement income! In fact, using other assets instead can be more tax efficient. Rather than expound theory, this assertion can best be illustrated by means of a case study. Let me introduce you to Tom, a wealthy individual. After a successful business career, he has reached 60 and has decided that he has had enough of work. He now wants to pursue other interests and has worked out that he will need approaching 100,000 income each year to do so. Just like every client you meet, Tom doesn t like paying tax especially as he paid loads of it when in business. He is well aware that a pension would be taxed at his highest marginal income tax rate and is receptive to other suggestions that would be more tax efficient. The way of doing this is actually to make capital realisations on a regular basis. It is a bit more labour intensive than setting up a monthly annuity and sitting back, but the taxsaving rewards are worth it. The first thing to do is find out just what assets are owned by Tom. He had been soundly advised to have a spread of investments, in a variety of tax wrappers, with the aim of taking the benefits when it best suited his circumstances. Tom s current assets are as follows: SIPP 800,000 ISA 120,000 OEICS 150,000 Offshore bond 600,000 SIPP Self-invested pension plan; ISA individual savings accounts; OEICS a portfolio of open-ended investment company shares. We know that he needs 100,000 income each year. He is only taking investment income of 3,000 gross on his OEICS, his ISA income being reinvested. He has stopped working and his state pension does not start for another five years. If he simply crystallised his SIPP, his pension commencement lump sum would fund two years tax-free income, but thereafter the more income he took the more tax he would pay. For example: Annuity income Effective rate of income tax 20, % 50, % 100, % The experienced financial planner would probably point out that, of course phased crystallisation would be a more taxefficient way of providing retirement income, but Tom s adviser has another suggestion no crystallisation at all. Tom s adviser suggests he takes income as follows: SIPP income of 0 ISA income and encashments of 8,000 OEICS dividends (gross) of 3,000 Full encashments of individual OEICS of 17,000 (with a capital gain of 10,000) Offshore bond encashments of 72,000 (with a chargeable gain of 24,000) Let us look at the tax implications of each of these suggestions in turn. 8

9 SIPP Although there is the temptation of taking the pension commencement lump sum (PCLS) and nil income, through drawdown, that would make the residual fund subject to the 55% recovery charge on any lump sum death benefit. In addition, the fund is tax-free although it suffers withholding tax. It could also be paid inheritance tax (IHT) free on death. ISA Another tax-free fund, unless you are an estate planner who knows differently: IHT being the only personal tax that the ISA is not automatically free from. At present, Tom is reinvesting his ISA income but could choose to have it paid out instead. Coupled with a withdrawal of funds, he could take 8,000 with 0% tax. OEICS dividends His OEIC produces 2,700 net in dividends from a portfolio of equity funds, which currently arises in accumulation units. Tom s adviser recommends that he switches his equity income funds from accumulation units to income units and banks the income distributions. OEICS encashments Tom is entitled to an annual exempt amount of realised capital gains, before he pays tax at 18% or 28%. This is a use it or lose it exemption, so it makes sense for Tom to take some profits on his OEICS without tax. These gains have to be within the limit of 10,600 for 2012/13. This will probably reduce his OEICS yearly income as well. In Tom s case, the cessation of his earned income is an excellent exit point. This is because so far, the adviser s recommendations have only generated 3,000 of taxable income and that income is taxed after offshore bond gains, which saves more tax. It is far better for Tom to offset taxable gains against his personal allowance rather than dividends with unrecoverable 10% withholding tax. The UK tax system To explain that last point, I have to take a diversion from our case study into the wonderful world of income tax. A necessary evil that has to be common knowledge for a financial planner. When HMRC are working out someone s income tax bill, they cumulate that person s income in a certain order: 1. Non-savings income, for example, income from employment or self-employment, or property income 2. Savings income (includes bank and building society interest, and gains made on life insurance policies (without a notional tax credit offshore bonds)) 3. Dividends and tax credits 4. Taxable lump sum payments 5. Gains on life insurance policies with a notional tax credit onshore bonds So, for example, the earned income may be taxed at basic rate but the dividends taxed at higher rate because the total at that point exceeds the higher rate tax threshold. Offshore bond encashments In past editions of Technical Eye, and in seminars ad infinitum, technical managers have contemplated the question of investment bonds or collective investments for clients. In truth, the answer is a bit of both in most cases, but the crucial factor with recommending investment bonds where taxation can be deferred for many years is to have an exit strategy. This is even more vital for offshore bonds, where chargeable gains are taxed at the policyholder s full marginal rate. 9

10 The interesting fact from the point of view of the suggestion made to Tom is that the offshore bond chargeable gains are before dividends, allowing him to offset them against his full personal allowance. Offshore bond tax calculation It was stated previously that Tom had offshore bonds worth 600,000 and it has been suggested he encashes 72,000 of these. The bond investment was 400,000 and it has 100 policy segments. The chargeable gain calculation is as follows: Current value = 600, segments encashed = 72,000 Segment value = 6,000 Less original investment = 4,000 Segment chargeable gain = 2, segments, so total gain = 24,000 So that is the chargeable gain, what is the actual income tax bill? Firstly, Tom s income is all savings income, so he will benefit from the 10% starting rate for savings income. This means that the first 8,105 of the offshore bond chargeable gain is not taxed as it is covered by Tom s personal allowance. The next 2,710 of gains is taxed at the 10% savings rate so 271 of tax to pay. The remaining 13,185 of gains is taxed at the basic rate tax of 2,637. This means Tom s overall tax on income or on receipts would be a more accurate term to use is 3,208 when 300 of withholding tax on the OEICs is added in. That is an effective tax rate of just 3.2%. Compared to an effective rate of 29.9% if it had all been annuity income. Inheritance tax Tom s strategy also has estate planning benefits. Because he is cashing in and spending investments that are subject to inheritance tax, rather raiding his pension fund which is free from estate taxes until age 75. From a pure estate planning point of view, the advice to clients could be don t touch your pension fund until age 75 and live off your other investments until that time. They could then crystallise, make a gift of the PCLS and transfer surplus net retirement income into trust using the normal expenditure out of income exemption! Fanciful perhaps, and it would be good to find a client in such a position, but the theory is sound. Conclusion Some clients do not have a choice in how they fund their retirement income; they may be members of a final salary scheme perhaps. But for those clients who have private or personal arrangements, they could benefit from a decumulation strategy. So make sure you emphasise to your pension clients that they should contact you before they crystallise benefits. Pre-retirement planning could save them a whole load of tax. We say Successive UK Governments have put the squeeze on the tax breaks for pensions; including making withholding tax not recoverable and gradually reducing the allowances. For the wealthy individual, this means that they will look to other legitimate methods of investing for their retirement. So financial planning comes into its own and the opportunity for you to demonstrate your expertise is excellent. If you need any help with decumulation or planning for retirement income, please contact your Canada Life account manager. 10

11 Collective investments and capital gains tax Cathy Russell and Jeremy Pearson This article sets out the rules relating to capital gains tax (CGT) and some of the major planning considerations when investing in collective investments. What is capital gains tax? Capital gains tax is a tax on the profit or gain you make when you sell or dispose of an asset. You usually dispose of an asset when you cease to own it - for example if you: sell it give it away (to other than your spouse or civil partner) transfer it to someone else exchange it for something else receive compensation for it - for example you receive an insurance payout when an asset has been destroyed As regards collective investments it's the gain that is made not the amount of money you receive for the asset that s taxed. Example A client invests in an open-ended investment company share (OEICS), paying 2,500 in June They sell the investment for 12,500 in May 2011 and they have made a capital gain of 10,000 ( 12,500 less 2,500). And a switch could be subject to CGT as it s a sale and new purchase. There are currently two rates of CGT; 18% for basic rate taxpayers and non-taxpayers and 28% for higher rate taxpayers, additional rate taxpayers, trustees and executors of deceased individuals estates. However, there is an Annual Exempt Amount (AEA) on which no tax is payable this is discussed in more detail later. Basic rate taxpayers and non-taxpayers have to add the gain to their total taxable income and if part or all of the gain exceeds the basic rate income tax threshold, they will pay 28% on the part of the gain that exceeds the threshold. Working out your gains or losses When you sell or dispose of more than one asset, you need to work out the gain or loss on each asset separately. This means if you are selling several different collective investments, you will need to do a separate calculation for each one. You should include any allowable costs associated with acquiring or disposing of the asset, and apply any tax reliefs. Bring all the individual gains and losses together to work out the gain or loss for the tax year and the amount of tax due. If you have unused losses from earlier years and these should be registered with HMRC (see losses below) you may be able to deduct them. However, capital gains tax is only payable if the overall gain is above the AEA (see the section below). How to calculate the gain or loss for each asset You must work out the gain or loss separately for each asset sold or disposed of. If a self assessment tax return and the additional capital gains tax pages (form SA108) are completed, you must attach each calculation with your tax return. In straightforward cases, you take the disposal proceeds (usually the amount received) and deduct the costs (including acquisition cost) and reliefs. This gives you the net gain or loss for each asset. In some cases, you may need to use the market value of the asset instead of the sale or purchase price see below. Example Mr F sells some OEICS in January 2012 for 30,000. He bought them in March 2000 for 40,000. The net loss is 10,000 ( 30,000 40,000). He ll need to tell HMRC about the loss if he wants to use it to offset other gains in future years. You can also download a working sheet from the HMRC web site at (CGN 20) and use it to calculate straightforward gains and losses. Market value Here are some of the main instances when you have to use market value instead of the sale or purchase price: Assets owned before 31 March 1982 capital gains tax is only paid on gains made since that date, so use the market value on 31 March 1982 instead. Inherited assets use the market value as at the date of death for acquisitions (or 31 March 1982 if later). 11

12 Gifts use the market value for disposals to other than your spouse or civil partner (or 31 March 1982 if applicable). Example Mrs B sells unit trusts in June 2012 for 60,000. She bought them in May 1973 for 4,000. Their market value on 31 March 1982 was 11,500. The capital gain is 48,500 ( 60,000 11,500). Acquisition and disposal cost calculating the gain or loss When disposing of an asset (for example, encashment or switch of a fund) you need to know the true acquisition cost and consider any costs relating to the disposal. In calculating the cost of both the acquisition and the disposal of an asset the diagram below can be used as a guide. Calculation Losses disposal proceeds, minus acquisition proceeds, minus any allowable enhancement costs, equals any incidental disposal costs, minus any incidental acquisition costs, minus the chargeable gain or loss Although it can make for an unhappy client if capital losses have been made, one saving grace is that those losses can be carried forward and offset against future capital gains. Once registered with HMRC there is no time limit for when they must be used. Gains and losses are calculated in exactly the same way. Losses will not be allowable unless the taxpayer advises HMRC of the amount of the loss within four years of the end of the tax year in which they were made. So if the loss is made in 2012/13, the claim must be made by 5 April The taxpayer can claim a loss via their tax return, or by writing to the local Inspector of Taxes. For part disposals, the principle is that allowable expenditure incurred must be apportioned between the part disposed and the part retained. Expenditure which relates wholly to the part disposed is deductible in full (normally calculated using the A/A+B formula see below). How to work out if you have CGT to pay Once you've worked out the individual gains and losses for each asset sold or disposed of you ll need to work out the overall gain to see if it s above the tax-free allowance. In most cases: 1. You add together all of your gains for that tax year. 2. You add together all of the allowable losses you ve made for that tax year. 3. You deduct any allowable losses made that year from the gains to work out the overall net gain. 4. If the overall net gain is below the annual tax-free allowance (known as the Annual Exempt Amount or AEA 10,600 for ), there s no CGT to pay. 5. If the overall net gain is above the AEA, you deduct unused losses from a previous tax year. Only deduct enough of the losses to reduce gains to the level of the AEA. You can carry the rest forward to future tax years. 6. If the overall gain is still more than the AEA, you have CGT to pay. Example Mr P made a gain of 20,000 on OEICS he sold in July He also sold some shares in July 2011 making a gain of 50,600. His total gains for are 70,600 ( 20, ,600). The AEA for individuals for was 10,600. Mr P s gains are above this amount so he has CGT to pay on 70,600 less any reliefs, losses and his AEA. Note that the AEA is deducted from the gain and not deducted from the tax liability. So his taxable gain is 60,000 ( 70,600 10,600). The next step is to work out which rate(s) of tax to use. 12

13 Working out the rate of tax to use For gains made in the tax year, individuals need to work out their taxable income before working out which CGT rate applies. Example If Mr P s taxable income in that tax year was 32,475, the gain of 60,000 ( 70,600 10,600) would take him into the higher rate tax bracket but he would pay 18% on the first 10,000 (to use up the available basic rate band) and then 28% on the remaining 50,000. The CGT bill is, therefore, 15,800 (18% x 10,000 = 1,800; 28% x 50,000 = 14,000). If Mr P s taxable income was 45,000, the gain of 60,000 would be fully taxable at 28% = 16,800. Losses and the AEA Allowable losses arising in the tax year are deducted from the total chargeable gains for the same year. To ensure maximum use of the AEA, it can be advisable to create losses and gains in separate tax years although this may not always be possible. If a loss and gain are created in the same tax year they must be matched against each other. You cannot choose to offset only part of the loss arising in the same year as the gain in order to utilise your AEA. In other words all the allowable losses for the tax year must be deducted up to the full amount of the gain even if this means your gains fall below the level of the AEA. Example Mr T sold some OEICS in May 2011 and made a gain of 15,000. He then switched some other OEICS in June 2011 and made a loss of 13,500. Mr T must match the losses against the gains in the same tax year before deducting his AEA. 15,000 13,500 = 1,500 is less than AEA so no CGT to pay but 9,100 ( 10,600 1,500) of his AEA has been wasted, in a sense. If Mr T had switched the OEICS that made the loss prior to 6 April 2011, the result would have been as follows: The OEICS switched on 4 April 2011 create a loss of 13,500. There are no other gains in the tax year so this loss is carried forward. Then in May 2011, Mr T sells the OEICS and makes a gain of 15,000. The calculation now looks like this: Gain in 2011/12 = 15,000 less 4,400 only of the carried forward losses = 10,600 the AEA. This means there is no CGT to pay and Mr T still has losses of 9,100 to carry forward to future years. Bed and breakfasting Because the AEA is a use it or lose it allowance, it can make sense to sell or switch assets or units solely in order to use the AEA. This will help reduce the eventual gain on final encashment of holdings assuming of course, that the investment increases in value! The traditional method was to bed and breakfast holdings, by selling them one day and then immediately repurchasing them the next day. There could be a cost involved, in terms of dealing charges or unit movements to contend with, but that is a small price to pay given the potential tax savings of 1,908 ( 10,600 at 18%) or 2,968 (at 28%). However, the rules changed as a result of the Budget on 17 March 1998 and nowadays, there must be a 30-day gap between the sale and repurchase of the same investment, for bed and breakfasting to work. 13

14 There must be a genuine transfer of beneficial ownership of the asset, so the repurchase of the asset cannot be agreed at the same time as the sale although this is unlikely anyway as regards OEICS. In practice, there are some ways in which a favourite fund can be bed and breakfasted effectively, such as: Bed and spouse you sell the units and your spouse buys an equivalent holding Bed and ISA you sell the units and buy the same fund in your ISA Bed and SIPP you sell the units and buy the same fund in your SIPP Bed and sector you sell the units and buy a different fund in the same sector (for example, UK equity income) Part disposal formula The part disposal formula is extremely important when calculating any tax liability and is used where only a proportion of the investment is disposed of. Let us consider a 400,000 investment where the client wishes to receive a 15,000 yearly withdrawal. Using the A over A plus B formula Purchase price x A / A + B Purchase price = original investment at start A = value disposed B = value of remaining investment The formula calculates how much of the withdrawal is original capital and therefore the balance is the gain. Let s look at our example. Example We have to make some assumptions: growth is 4% each year after charges and the full CGT AEA is available. 400,000 grows to 416,000 and client withdraws 15,000: Purchase price x A / A+B 400,000 x 15,000 / 15, , ,000 x = 14,423 We now know that 14,423 is return of original capital which means that the amount chargeable for CGT purposes (the gain on this withdrawal) is 577 ( 15,000 14,423). This is well within his AEA so therefore no CGT to pay. One point to remember is in year 2 (and all future years) the original capital figure has to be re-based as he has now had some original capital back. So at the end of year two the purchase price will be 400,000 14,423 = 385,577. It is worth remembering that a partial switch will give rise to a CGT calculation for part disposal. Equalisation When a client invests in a collective investment, the first distribution of income will include something called equalisation. This can cause confusion as it is not a well-known term but it is important, as it has to be factored in to the CGT calculation which can be many years hence. Equalisation is a way for the fund provider to be even-handed to new and existing investors. When investors buy a collective part way through an income distribution period, income (dividends, interest and other) will have already accrued to the fund. The red circle depicts the original investment and the light ring around this depicts year 1 growth. Think of this as a pie and you will see that when you take a part disposal you are taking a slice of pie. Therefore you will receive some original capital and some growth. 14 For example, if the distribution dates are June and December and a client invests during September, why should they be entitled to any income accrued between June and September? And of course, they shouldn t be taxed on it either! Of course, the fund provider is not going to work out the relevant figure for every single investor during a distribution period, so what they do is average it out for all new investors.

15 So a distribution may be 1p for each unit with the equalisation payment being 0.5p for each unit. For tax purposes, equalisation is treated as a return of capital. So it is not income, but as a return of capital it reduces the acquisition cost for CGT purposes. Income units and accumulation units In both cases, whether new units are allocated to the investment following a distribution via interest or dividend (income units) or existing units are increased in value after the distribution (accumulation units), the distribution is potentially liable to an income tax charge. From 6 April 2008, where identical assets have been acquired at different times, the existing last in first out (LIFO) rule does not apply and has been replaced by a simplified approach. Principally the assets will be pooled (known as a Section 104 holding) and these assets will have a single acquisition value based on the average cost of all the assets purchased within the pool. If the collective investment is in income units, the first distribution made after a client invests will include equalisation. So this part of the income payment is not subject to income tax, being a return of capital as stated above. This also applies if the income distribution is reinvested into further units. The additional investment will increase the acquisition cost when calculating capital gains. For accumulation units, the first notional distribution after investment will include equalisation. Of course, in this case further units are not purchased and the reinvested income increases the unit price. However, the part of the reinvested income that was not equalisation is still liable to income tax. This will be disregarded for the purposes of calculating CGT. So the net notional distribution will be deducted from the sale proceeds when calculating any gain and the equalisation, as we know, is a return of capital. The first table assumes that income is reinvested to purchase further units. Income units capital gain Acquisition cost 10,000 Net income received 100 Equalisation 50 Revised acquisition cost 9,950 Sale proceeds 10,500 Capital gain 550 Now let us look at if the holding had been in accumulation units. Accumulation units capital gain Acquisition cost 10,000 Notional income received* 100 Equalisation 50 Sale proceeds 10,600 Notional income reinvested 50 Adjusted sale proceeds 10,550 Capital gain 550 * 100 minus equalisation payment of 50 How to report capital gains (and losses) The investor will need to complete a self-assessment tax return (form SA108 the additional capital gains tax page) if any of the following apply: the capital gains are more than the annual exempt amount ( 10,600 in 2012/13) the total amount received from disposing of assets is more than 42,400 (that is, four times the exempt amount) even if there is no CGT to pay. losses have been made and they have to be registered so that they can be deducted from gains in the future. We say The use of collective investments is widespread and knowledge of the tax implications is essential. In addition, it is a requirement of the increased professional standard required of advisers nowadays. The old days of bonds vs unit trusts are long gone, as most advisers appreciate that both have a place in most client s portfolios. If you have any questions about capital gains tax, please contact your Canada Life account manager or the Canada Life Technical Services Team. Contact details are on the inside back cover. 15

16 Charging up Paul Thompson One effect of the Retail Distribution Review (RDR) is that, where an investment bond is taken out after the end of 2012, commission can no longer be paid to the adviser. If advisers are to be able to continue to put food on the table, they will need to understand the ramifications of Adviser Charging. There are three methods by which this can be achieved although, as we shall see, complications can arise where the bond is subject to a trust. There are two aspects that need to be considered the Initial Adviser Charge and Ongoing Adviser Charges. Perhaps the simplest method of collecting the Initial Adviser Charge is for the client to send a cheque to the adviser and to send a separate cheque to the product provider. However, the rules do allow for the payment of just one cheque to the provider, using one of two methods. Provider facilitated The first is provider facilitated. Here, the client pays the cheque to the provider but, before investing it into the bond, the provider separates out the Initial Adviser Charge, pays that to the adviser and invests the remainder in the bond. Product facilitated The alternative, which is product facilitated, is for the client again to pay the cheque to the provider who invests the whole amount in the bond. Immediately afterwards, a withdrawal is taken from the bond in respect of the Initial Adviser Charge and the provider pays this to the adviser. So what s the difference? By way of example, let s assume a client with 100,000 to invest and an Initial Adviser Charge of 3,000. Where the client pays one cheque to the adviser and another to the provider, 97,000 will be invested in the bond. Similarly, where the Initial Adviser Charge is provider facilitated, 97,000 will be invested in the bond. If it s product facilitated, however, 100,000 will be invested in the bond. This means that future 5% withdrawal allowances will be based on 100,000 and not 97,000. However, as the Initial Adviser Charge has been generated from a withdrawal of 3,000 in the first year, only 2% of the first year s allowance will be available to the client. It should be borne in mind that, where the bond is subject to a trust, the product facilitated option will not be available, since it would result in benefits being paid out of the trust for the benefit of the settlor in effect, inevitably resulting in a gift with reservation for inheritance tax (IHT) purposes. Ongoing adviser charges So, what about Ongoing Adviser Charges? These can be collected as a withdrawal from the investment bond, although it should be recognised that this will utilise part of the 5% annual tax-deferred allowance. Policies written under trust will be in a similar position. Since ongoing advice will be paid for by the trustees, they can take withdrawals from the bond to generate the Ongoing Adviser Charges. Care may need to be taken where the 5% allowance is already being utilised (such as for discounted gift trusts or loan repayments under a gift and loan trust) to ensure that the payments under the trust plus the Ongoing Adviser Charges don t inadvertently create chargeable gains by exceeding the 5% allowance in total. Where a trust policy is subject to Ongoing Adviser Charges, the settlor may decide to pay these on behalf of the trustees. Although this is perfectly acceptable, it should be recognised that these will be additional gifts from the client to the trust. Whilst they may well fall within one or more exemptions from IHT, if they don t they will be potentially exempt transfers if it is a bare trust or chargeable lifetime transfers if it is a discretionary trust. Whether under trust or not, advisers need to consider the position of pre-rdr policies that have increments paid in the form of top-ups post-rdr. If the pre-rdr policy still has trail commission being paid, many providers will be unable to continue that if a top-up is paid post-rdr, meaning that the trail commission will have to be replaced by Ongoing Adviser Charges. Other providers (including Canada Life), however, will have the ability to continue the trail commission on the pre-rdr business and Ongoing Adviser Charges will be restricted to the post-rdr top-up. Which would you rather use? We say RDR has brought with it many challenges and its impact on the chargeable gain situation is just one more. Whilst taking adviser charges as a withdrawal from an investment bond can make life easier, it will be necessary to ensure any fund-based charge does create chargeable events in future perhaps by imposing a cap on the amount. For more details of the interaction between adviser charging and chargeable events, please contact your Canada Life account manager. 16

17 Why some females got an unexpected early Christmas present Nigel Orange The Gender Equality (GE) Directive from the European Union states that when it comes into effect, it will be unlawful to use gender as a differentiator in insurance and other financial products. As far as annuities are concerned, females can look forward to getting exactly the same income as their male equivalent when converting their pension pot into income. This is as decided in European Court of Justice (ECJ) Case C-236/09 Association Belge des Consommateurs Test-Achats ASBL and others v Conseil des Ministres and became effective on the 21 December Although current mortality experience still show females continue to outlive males (the gap is reducing), this can no longer be used as a reason to price differently. Gender specific rates were used up to the deadline but quote guarantees expired before 21 December Overall impact So what is the overall impact of the new rule as far as pensions and annuities are concerned? Not all pension schemes and retirees will be affected and this is covered later on in the article. Providers are expected to launch unisex rates with females better off by around one to two percent and males losing out by slightly less. It might be worth noting that because many more males buy annuities than females, this has been an influential factor when pricing for unisex rates. Some confusion still exists about the way the Test-Achats ruling applies to work-based pension schemes and other types of pensions. The Equal Treatment Directive (EC 2006/54/EC) applies to occupational pensions and still permits gender-specific pricing, whilst the Gender Directive, which does not, applies to other types of pensions. However the ECJ judgement, and official guidance, suggests that where an annuity is purchased using funds held in a work-based pension scheme and without the involvement of the employer or the scheme, the purchase would fall within the scope of the Gender Directive and therefore would be subject to gender-neutral pricing. In principle this creates an incentive for female members of an occupational scheme to use the Open Market Option (OMO), but conversely a disincentive for male members. Capped drawdown arrangements How does the directive affect capped drawdown arrangements? HMRC has issued revised guidance on the use of Government Actuary s Department (GAD) tables for drawdown, stating that until it becomes clearer how annuity providers will apply the judgement the maximum drawdown pension for both men and women aged 23 and over should be calculated using the higher male rates in Table 1 from 21 December This will apply to the calculation of the maximum drawdown amount where the commencement or review of an individual s capped drawdown benefits is taking effect after 21 December 2012, and will mean that: women will be able to take a higher drawdown pension income than before; men will see no change in the maximum drawdown pension they can receive; drawdown providers can continue using the existing Table 1, but for more of their customers; It applies equally to occupational money purchase schemes offering drawdown and personal pensions. In making this announcement HMRC has listened to industry concerns. Recognising the enormous pressure on drawdown rates created by plummeting gilt yields, HMRC decided upon a damage limitation exercise and in addition announced in the Autumn statement that the maximum income available from a capped drawdown arrangement will revert back to 120% of GAD. Thus, if opting under scheme rules to crystallise benefits via drawdown, male members will be no worse off and females better off, until further notice. We can only hope that any permanent change be announced as soon as possible. We say We could have done without GE impacting on the industry just 10 days before the Retail Distribution Review (RDR)! Let us hope that the outstanding issues get resolved quickly and that the position can settle down before too long. If you need any help with the impact of gender equalisation on annuities, please contact your Canada Life account manager or the Canada Life Technical Services Team. Contact details are on the inside back cover. 17

18 A DIM trio for VAT Neil Jones Recently there has been a great deal of publicity around VAT and discretionary fund managers or discretionary investment managers (DIMs), as the FSA now refers to them. A mixture of discretionary fund management and VAT conjures up a number of different discussions. Three immediately spring to mind: the differing VAT treatment of offshore jurisdictions Deutsche Bank in the European courts the effect of VAT when recommending a DIM Rather than look at just one, let s consider each of these areas. The DIM, the IRC and HMRC When selecting a jurisdiction there are a number of factors to take into account. One area that has seen discussion is around the use of Dublin-based investment bonds when utilising the services of a DIM for a UK investor. Of course, it is assumed that it will have been determined, through advice, that the DIM is most (tax) suitably accessed through an offshore bond for the particular investor. That said, where a UK policyholder appoints a DIM to manage the underlying investment, they will charge a fee. The invested assets will be owned by the life company and therefore the contract for services will be between the Irishbased provider and the UK-based DIM. The Irish government has deemed this not to be chargeable to VAT, but why, as this contradicts HMRC s stance? Under the EU VAT directive there is a VAT exemption for managers of special investment funds. However, and this is key, it is up to each individual member country to define what a special investment fund is. The Irish Revenue Commissioners (IRC) long-standing belief is that this exemption may apply to the services performed by a third party in respect of investment and the administrative management of a fund. This would therefore catch the mandates given to DIMs by Irish-based insurance companies. By why does HMRC not interpret it in the same way? HMRC initially limited the definition and therefore the exemption to unit trusts, open-ended investment company shares (OEICs) and trust-based schemes. The list was expanded in 2008 to include close-ended investment trusts following the Claverhouse case. This ruled that, while member states had discretion in defining special investment funds, they must consider the purpose of the exemption and fiscal neutrality. From this explanation you can clearly see that there is not fiscal neutrality across EU member states. HMRC believes its interpretation is correct, as do the IRC. So, where to now? Any review will take years to resolve and who knows what the resolution will be, but there needs to be consistency. Whatever happens, this issue only arises when using a DIM and is only one consideration for selecting a jurisdiction for an investment. Deutsche Bank: I was defeated you won the war Initially some commentators felt that the Deutsche Bank case would help settle the Dublin VAT issue explained above. This is not the opinion of the IRC as they believe it refers to a different precedent. So, let s consider what this case involved. Deutsche Bank ran discretionary portfolios for investors and this included the management and administration, maintaining the holdings within a prescribed mandate without reference to the individual investors. For this service it charged 1.8% of the value of the portfolio. This fee was broken down into a management fee of 1.2% covering the investment decisions and an administration fee of 0.6% covering the cost of buying and selling the securities. In May 2008 when the Bank completed its provisional VAT return, it declared the portfolio management services as VAT exempt. It felt that it was providing a combination of advice, execution and administration, exempt under the VAT directive as transactions in shares and other securities. The Finanzamt (the German tax authority) took a different view, claiming the service was advisory in nature and that clients would be buying the investment expertise of Deutsche Bank. So they decided to settle this through the courts. The European Court of Justice (ECJ) ruled in 2012 following an announcement by the Advocate General, Eleanor Sharpston. She felt that when the services are combined, even though they can be separately identifiable, the client is buying a single service. And, due to the nature of the overall service, VAT should apply to the whole fee. This surprised some people who felt that VAT may apply to the advice and not the administration. The subsequent ECJ ruling followed her recommendation. 18

19 Recommending a DIM Most will be aware of what the FSA is trying to achieve with the Retail Distribution Review (RDR). However, the changes have consequences, the recommendation of DIMs being one. The fees for providing financial advice are VATable, but the fees for arranging a financial product are exempt as intermediation. HMRC has issued guidance on the interaction between the two; however, the recommendation of a discretionary manager is VATable, so if there is advice and a recommendation for a DIM, then the whole fee is potentially VATable. This is clearly a very important issue to the sector given the growing adoption of outsourced investment management by advisers. Advisers would, of course, be looking to ensure that all of the fees they charge in an advisory relationship were VAT exempt if the advice incorporates intermediation. HMRC has announced a consultation on this and, whilst the results had been expected before Christmas 2012, it is unrealistic to expect any implementation before the RDR, so we can expect a transition period into Each one of these topics could be an article in their own right and go into a lot more detail. So when someone starts talking about DIMs and VAT then think about which aspect they are discussing and if there is an interaction between the different areas. We say Keeping costs down when recommending an investment solution is desirable and avoiding VAT can help with that. But it is a complex area and one which is not yet completely resolved. We will issue updates as soon as we learn more. If you would like to be kept updated in this issue, please contact your Canada Life account manager. Who s offered the best protection for the past four years? When it comes to offshore investments, we know your clients are only interested in the best-performing, strongest and most reputable companies. So we re delighted to remind you that we have won the International Adviser Best Protection Product for the past four years. Indeed, after 25 years of unrivalled strength we now have 7.8 billion* assets under administration, plus a cluster of other awards that tell their own story. And with the added stability of being part of Great-West Lifeco, one of the top ten largest insurance organisations in the world, it s hard to imagine a more attractive option offshore. * As at 30 September For more details call us on +44(0) or visit 19

20 Chargeable transfers why you should think outside the band Jeremy Pearson Since the taxation of interest in possession trusts changed in March 2006, there has been an unwritten rule amongst estate planners that you should not do a chargeable lifetime transfer for more than the nil rate band. But making a larger chargeable transfer, and paying an inheritance tax charge immediately, can give rise to much larger tax savings. Thinking outside the box or perhaps it should be thinking outside the band can be very worthwhile. Whilst not wishing to be pedantic, you could also add on any unused annual exemption(s) to that figure, of course. It should also be remembered that whilst legal personal representatives can claim a transferable nil rate band after death, that cannot be claimed by a donor for lifetime gifts. This meant that clients who were prepared to make gifts into a discretionary gift trust or flexible reversion trust and had more than 325,000 to give away had to use a bare trust for the balance with all its inherent drawbacks or use a gift and loan trust. (For simplicity, I am excluding discounted gift trusts from this article.) This is because a transfer into a discretionary trust of an amount larger than the nil rate band would generate an initial charge to the lifetime rate of inheritance tax (IHT) currently, 20%. So a transfer to a discretionary trust of 425,000 (ignoring the annual exemption(s)) would result in an immediate IHT bill of 20,000 for the trustees. Understandably, advisers shied away from suggesting such a size of chargeable transfer in fact, I have never seen one. But solicitors do recommend large transfers into discretionary trusts, so why do they have a different viewpoint? Perhaps it is because they have done the maths and know that paying some tax up front can lead to greater savings later on? Admittedly, it is a difficult job to convince a client to pay tax in advance for any reason, but if they are prepared to make a gift of 425,000 would it be so unpalatable if the trustees were left with 405,000 to invest (in my example)? Given that the long-term effect can be beneficial as I am about to explain. One should not overlook the fact that declarations have to be made to HMRC and the tax paid within six months or so, but these requirements can be factored into the advice given. To demonstrate the effect of making a large chargeable transfer, I am comparing three situations for a wealthy client: 1. Doing nothing 2. Making a gift to a discretionary trust of 325, Making a gift to a discretionary trust of 2 million The client is a widow and lives in a house worth 850,000. For simplicity, we are going to assume her other assets are 2 million on deposit and that she has sufficient income from a pension. A full transferable nil rate band is available. She wants to give away as much money as possible to her family, with the minimum of IHT being payable. She is in good health and her life expectancy is 10 years, so we will compare the three alternatives over that period. Just in order to demonstrate the principles involved, initially we will assume that the value of the assets and the nil rate band remain unchanged. 20