Personal taxation

Tax wrappers or investment vehicles are containers for direct investments or funds. They have very different tax treatments and th...

Shortened demo course. See details at foot of page.

...ding on the wrapper used, part or all of the proceeds may be tax-free or they may be fully subject to income or capital gains tax.

To encourage individuals to save for their retirement, registered pension schemes have a number of tax advantages:

Registered pension schemes have the following tax benefits:

Tax relief on the funds invested

Freedom from UK tax on capital gains and most investment income within the fund

Freedom from tax on up to 25% of the fund when the pension benefits are taken

Death benefits payable before the member reached age 75 are tax-free

Due to these benefits there are limits on the amounts that can be invested and it is important to realise that at retirement, when the benefits of the fund are taken (known as ‘crystallisation’), although up to 25% of the fund can be taken tax-free the remaining pension income will be taxed as if it was earned income, but it will not have any liability for NICs.

There are three ways that investors in defined contribution pension schemes, such as personal pensions, can access their pension funds at age 55 (this will increase to 57 from 2028 to match the increase in the state pension age):

Funds can be crystallised , with 25% of the fund taken immediately as a tax-free lump sum (pension commencement lump sum (PCLS)). The remainder can then be withdrawn as flexi-access drawdown, taking amounts as required. These future withdrawn amounts are treated as income and subject to income tax at the investor’s appropriate rates

Funds can be left uncrystallised . Withdrawals can then be taken from the fund as required with 25% of each withdrawal being tax-free and the remaining 75% treated as income and taxed at the investor’s appropriate rates in the year of withdrawal. This is known as an uncrystallised funds pension lump sum (UFPLS)

After taking a 25% tax-free lump sum an annuity can be purchased to provide a regular income. This will be taxed at the investor’s appropriate rates when the income is received

There is no requirement for member...

Shortened demo course. See details at foot of page.

...raw more than their maximum allowed income, calculated by the pension scheme administrator at the time the arrangement was first set up.  Individuals with these arrangements will have the full annual allowance of £60,000 available (or less if the tapered allowance has been triggered), but if the maximum income amount (the cap) is breached, they will become subject to the reduced money purchase annual allowance and their fund is then treated as flexi-access drawdown.

There is no requirement for members of a registered scheme to crystallise their benefits.  A PCLS can be taken whenever benefits are crystallised (this can be later than age 75) but it can only be taken along with a ‘relevant pension’ (lifetime annuity, scheme pension or drawdown arrangement). If a PCLS is taken when funds are designated to a flexi-access drawdown there is no requirement to take the income from the drawdown fund at that time.

The uncrystallised funds pension lump sum (UFPLS) is another method of accessing pension funds without having to designate funds for drawdown or purchase an annuity.  When each payment is taken, 25% is considered the tax-free lump sum amount and the remainder is taxable as income.

Investment rules

For all types of pensions, there is one set of investment rules. Investments in residential property (with a few exceptions) and in tangible moveable assets (antiques, art, wine, etc.) may invoke a penal tax charge. Borrowing to fund property purchase or any other investment cannot exceed 50% of the net value of the fund.

Taxation of the fund

Pension funds are free of UK tax on investment income and capital gains.

Penalties

Where the annual allowanceis exceeded, there are substantial tax penalties and there are also penalties for making unauthorised payments.

Explain how tax relief is given on contributions by individuals to a pension provider.

Answer : Purchase course for answer

Individual Savings Accounts (ISAs), Junior ISAs and Child Trust Funds (CTF) can both hold a mixture of cash and stocks and shares while having tax advantages for the investor.

Individual Savings Accounts (ISAs)

ISAs are available to individual investors who are resident in the UK and non-resident crown servants liable to UK income tax. Individuals aged 16 and above can invest in a cash ISA, but to hold a stocks and shares ISA, innovative finance ISA or Lifetime ISA, the investor must be aged 18 or over.

An investor who invests in more than one ISA (either of the same type or a different type) in a tax year can use the same or different providers.

A cash ISA could be invested in bank or building society deposits or money market unit trusts which hold deposits. National Savings and Investments also offers a direct cash ISA. A stocks and shares ISA could be invested in:

unit trusts

OEICS

investment trusts

UK Undertakings for Collective Investment in Transferable Securities (UK UCITS)

shares listed on a recognised stock exchange (including the Alternative Investment Market AIM), corporate bonds, Government securities from the European Economic Area, life assurance policies and cash being held for future investments

For each type of ISA (unless stated otherwise), an individual can invest up to £20,000.

If an individual wanted to have more than one typ...

Shortened demo course. See details at foot of page.

...s opened by the parent or guardian of the child on the child’s behalf. When the child reaches age 16, they can then take over responsibility for it.

There are three main types of account:

Savings Accounts

Accounts investing in shares

Stakeholder Accounts, which also invest in shares but in ways that attempt to minimise the risk, and charges limited to 1.5% a year

The funds can be moved between providers.

Invested funds must stay in the account until the child is at least 18, unless they become terminally ill. On reaching 18 the money can be used as the child wishes.

The investment grows free of income tax and capital gains tax and is exempt from the rule where interest in excess of £100 per year is treated as the parent’s income if the capital on which the interest was earned came from the parent.

Children born after 2 January 2011 do not qualify for a Child Trust Fund account. Accounts already set up continue to benefit from the tax advantages and are subject to the existing withdrawal restriction. Parents and others are still able to add additional funds up to the current annual maximum each year, which has been increased to the same level as the Junior ISA.

Funds held within a Child Trust Fund can be transferred to a Junior ISA.

Apart from those who are resident in the UK, who can also hold an ISA?

Answer : Purchase course for answer

Similar to an investment into an investment trust, which we examined in the last chapter, investment in a unit trust or Open-ended Investment Company (OEIC) allows an investor to hold a spread of shares in a pooled investment structure along with many other investors. They can be purchased by individual investors or held within a wrapper such as a pension, ISA or other ...

Shortened demo course. See details at foot of page.

...nd is paid gross.

Unit trusts and OEICS differ from investment trusts in that they are open-ended. Units or shares are issued when money is invested and liquidated when the holdings are sold by investors. The units or shares are sold back to the fund manager.

What costs are involved in the investment in a unit trust or OEIC?

Answer : Purchase course for answer

Offshore investment funds are marketed by many institutions, with the underlying funds invested in equities, fixed-interest stocks, commodities and currency trading. They are generally set up in countries with little or no local taxation, such as the Channel Islands, Isle of Man or Luxembourg.

Many of the funds have an OEIC structure and managed by the offshore arm of UK investment groups.

For the individual investor, offshore funds are categorised in one of two ways for tax purposes; either a reporting fund or a non-reporting fund.

Reporting fund

A fund can apply to HMRC for reporting status, which will be granted if it reports all of its income to HMRC. UK investor...

Shortened demo course. See details at foot of page.

...is will escape all UK tax liability, including inheritance tax, but they may have to pay the annual remittance basis tax charge of £30,000 or £60,000.

The funds themselves, although based in tax havens, are not entirely tax-free. If an offshore fund invests in equities, the dividends received will normally have been subject to a non-reclaimable withholding tax. Fixed-interest funds are generally more tax-efficient for UK-resident investors because they choose investments which pay income gross. Some jurisdictions levy a small amount of tax on offshore funds.

How is the gain on an encashment from a non-reporting fund taxed?

Answer : Purchase course for answer

These investments provide a return linked to the performance of equity investments, usually an index such as FTSE 100, with an element of this guaranteed.

The returns are normally achieved by the providers using a combination of investment types - deposit or fixed-interest securities and a derivative of the chosen equities.

Growth products will give a minimum level of return, which is frequently the original investment amount with a low rate of interest plus a stated proportion of the growth of the linked index.

Income products...

Shortened demo course. See details at foot of page.

...re territories. Income received from them is treated as dividend income (this will be considered fully in a later section of this chapter) and capital gains are liable for capital gains tax.

Listed bonds or medium-term loan notes are fixed term contracts issued by UK and EU banks. The income is taxed as savings income and liable for income tax. Capital gains are liable for capital gains tax.

State how the returns on Protected and guaranteed (structured) equity products are normally achieved.

Answer : Purchase course for answer

The taxation of life assurance-based investments is a complex area and firstly depends on whether or not the policy is considered to be a qualifying policy.

Qualifying policies

Qualifying policies are generally those with regular, level premiums which are payable at least annually for a minimum of ten years. This means that many endowments and whole of life policies fall within this category. For qualifying policies issued after 6 April 2013, an individual’s premiums across all policies are restricted to £3,600 per year.

Qualifying rules

A capital sum must be paid on death or disability 

Premiums must be paid at least annually

Premiums must be paid for at least 10 years or until disability or death

Premiums paid in any one year must not exceed twice the premiums in any other year

The total premiums paid in one year must not exceed one eighth of the premiums payable over the whole term

The death benefit must not be less than 75% of the total premiums payable over the term of the policy

Certain policies are exempt from the above rules. These are:

Those issued in connection with an approved superannuation or pension scheme

Those providing a sum substantially the same as a mortgage on a residence or business premises, i.e. Decreasing Term Assurance

Non-qualifying policies

Non-qualifying policies are those which do not fall within the qualifying rules and are generally those which are single premium policies used more for investment purposes than actual life cover.

Tax on life policies

The taxation of life policies applies to both the life office providing the policy and the individual policyholder.

Life Company

The life company will invest the premiums received from their policyholders into their life fund. The fund will effectively pay no tax on its dividend income from the UK but will pay tax on interest income from property rental, offshore income gains and cash deposits at 20%. If the fund sells any assets at a profit, they will be liable for tax at 20% (with relief for inflationary increases to 31 December 2017, not beyond). These taxes are paid directly by the life office and cannot be reclaimed by any policyholders.

Policyholder

Firstly, it is important to realise that although a life assurance policy may provide the policyholder with a chargeable gain, the liability will arise for income tax and not capital gains tax.

How the individual policyholder will actually be taxed depends on whether or not the policy they hold is considered to be a qualifying policy. Where the policy is a qualifying policy, it is generally only gains that occur in the first 10 years when a policy has been made paid up or surrendered that will be liable for income tax. Where the policy is a non-qualifying policy, gains that occur at any time are potentially chargeable.

Chargeable events

The policyholder will have a potential liability for income tax from a non-qualifying life policy if a chargeable event occurs. Chargeable events are:

Death

Maturity

Surrender

Part-surrender

Assignment for money or money’s worth

Policy loan

These are not considered chargeable events:

Assignments by way of a mortgage

Assignments between spouses or civil partners who are living together

Payment of a critical illness benefit

A loan at a non-commercial rate of interest on a qualifying policy made before 6 April 2000 by the issuing office to an employee for the purposes of house purchase or improvement

A policy loan at a commercial rate of interest in respect of a qualifying policy

It is important to be aware that during the lifetime of a policy there may be more than one chargeable event that occurs. For example, half of a policy may be surrendered after a number of years with the other half remaining in force, so a chargeable event has occurred on the part-surrender, then after a further number of years the policyholder may die, giving rise to a second chargeable...

Shortened demo course. See details at foot of page.

...th or the gain was in excess of half of the current tax year’s basic rate band.

Any amount of gain will be included in the taxpayer’s income to calculate personal and age allowances, working tax credit and child tax credit and may reduce the entitlement or totally eliminate it. 

Traded endowment policies

Many holders of endowment life assurance policies do not hold them until maturity but trade them on the open market as second-hand policies. They are legally assigned to the new owner who continues to pay any required premiums until either the policy’s maturity or the death of the life assured, when the benefits are paid to the second owner.  If the policy is a qualifying policy, there will be no tax to pay if it is traded, provided premiums have been paid for at least 10 years or three-quarters of the term if sooner. Otherwise, the tax situation will be as we have covered in this section.

As the disposal of a second-hand qualifying policy does not generally give rise to a gain liable for an income tax charge, there may be a charge of capital gains tax.

Trust policies

The tax situation for life assurance policies placed under trust is slightly different.

If the person who created the trust is alive and resident in the UK immediately before any chargeable event, any chargeable gain is treated as part of their income. They can, however, reclaim any tax paid from the trustees of the trust.

If the person who created the trust is dead or resident outside of the UK immediately before any chargeable event, but one or more of the trustees are resident in the UK, then any chargeable gain is chargeable on the trustees at a rate of 45%. The amount paid will actually be 25% due to the tax already deducted within the life fund. This tax cannot be reclaimed by the beneficiaries even if they would not have been liable in their own right.

If the trustees are not resident in the UK, any beneficiary of the trust who receives the benefit of any gain will be liable for the tax without any top-slicing relief.

The tax could be avoided by the trustees retiring and being replaced by trustees who are non-UK resident before the chargeable event. This makes the beneficiaries liable at their individual tax rates and, if they are basic rate taxpayers after the addition of any gain to their income, there would be no liability (though top-slicing cannot be used for this purpose). Alternatively, the trust policy could be assigned to a beneficiary before any chargeable event. The policy could then be surrendered by the beneficiary with the tax liability falling on them individually, where they would be able to benefit from top-slicing relief.

Friendly Society policies

Friendly Societies are able to sell qualifying policies with limited premiums, with the funds being free of UK tax on income and capital gains. These are known as exempt policies . The returns from these are potentially greater than those policies issued by a life office that will suffer tax within the fund.

Due to the tax advantages, there are limits on the premiums per policyholder of £270 per year or £25 per month where premiums are paid more frequently than annually i.e. £300with the totals applying to all friendly society policies held by an individual. As children can also have these policies, parents can have their own policy for the maximum £270 plus one for each child.

The actual taxation is similar to that of qualifying policies in that there would be no tax charge on a 10-year policy held to maturity. If a chargeable gain is made on a friendly society policy, there is no available tax credit and the full rate of tax is payable by the policyholder.

George invested £10,000 into a single premium life assurance bond on 8 June 2020. On 16 July 2024, when it is worth £11,300, he wishes to make a partial withdrawal. How much can he withdraw without any immediate liability for income tax?

Answer : Purchase course for answer

An annuity is a policy purchased with a lump sum that then pays the annuitant, on whose life the policy is written, a given amount every year while they are alive.

There are different types which are treated slightly differently in relation to tax.

Purchased life annuities

These annuities provide payments which are split into two elements: a capital element, which is the funds paid for the policy, and an interest element. The capital element is fixed at the start of the policy and remains at the same level throughout. It is calculated from mortality tables, set out by HMRC, by dividing the purchase price by the life expectancy of the annuitant. It is considered as a return of the invested capital and is not taxed. If the annuitant lives as expected in the mortality calculation, they will have received back all the capital they invested tax-free. The interest element of each payment is considered to be savings income and is taxable. Tax is deducted at source at the basic rate, so higher rate taxpayers would have a further liability.

Annuities which are dependent on human life can be deemed purchased life annuities, except in certain situations. These are:

An annuity already treated as part capital and part interest, ie an annuity certain

Where it is purchased by direction from a will or settlement

Where purchas...

Shortened demo course. See details at foot of page.

... life annuity when the annuity is taken

Annuities for beneficiaries under trusts or wills

Taxed in full as savings income

Administration of the tax

The life office deducts tax, where applicable, at the basic rate and pays the annuitant the net amount. The annuitant is provided with a certificate from the life office showing the amount of tax that has been deducted and periodically the life office will pay the deducted tax to HMRC.

In certain circumstances HMRC will allow life offices to make annuity payments without deduction of tax. Where the annuitant’s total income is unlikely to make them a taxpayer, they can complete a form R89 . When received and approved by HMRC, the life office can then make payments gross (provided that the annuitant’s income does not exceed the appropriate personal allowance).

On joint annuities, the income can also be paid gross where both of the annuitants are unlikely to pay further tax.

These arrangements are only applicable to annuitants who are resident in the UK.

Many countries have double-taxation agreements with the UK, to prevent annuities being received by non-UK residents being taxed twice. Where such an agreement exists, it is likely that the annuity will be paid without deduction of UK tax but liable for tax in the country where it is received.

UK investors now have access to many offshore products which have the advantage of being established in countries with low taxation, allowing the investment to grow virtually free of tax (known as gross roll-up ) , though the funds themselves may suffer withholding taxes on their income. Although the funds may grow with tax advantages while invested, the tax position for the individual investor when they are withdrawn is often different from that on investments within the UK.

Where a UK resident holds an offshore policy and a gain arises, they will be liable for income tax at their highest rate on the whole of the gain, reflecting the fact that no UK tax has been paid on the underlying fund.

Where the policyholder has been resident in the UK for the entire term of the policy, the whole gain is chargeable. Where resident outside of the UK for the whole term, the gain is zero. Some relief may be available where the policyholder has spent periods of time outside of the UK during the term of the policy. The amount of chargeable gain is calculated by multiplying the total gain by the fraction - number of days for which the policyholder was resident in the UK/Number of days policy has run.

There is no apportioning of reli...

Shortened demo course. See details at foot of page.

...st state that the policyholder was not resident in the UK when the policy was made and must state the country of residence. The policyholder must also undertake to inform the insurance company if they become a UK resident. For policyholders who are not UK citizens, the certificate must state the country of residence and that the life office has no knowledge that would make it assume that the policyholder was a UK resident.

If a policy changes hands, a further certificate is required for the new policyholder if it is to remain OLAB. The OLAB status will be lost if the insurance company learns within 18 months of the policy date that the policyholder was resident in the UK within 12 months of the policy date. Otherwise, the policy does not lose OLAB status if the policyholder later becomes resident in the UK.

An OLAB policy is not a qualifying policy and therefore is treated for tax purposes as an offshore policy, if it was effected after 17 March 1998 or varied on or after that date to increase the benefit or extend the term. Any taxable gains are therefore charged at the basic, higher or additional rates as appropriate.

When must an offshore life office appoint a UK tax representative?

Answer : Purchase course for answer

Trusts involving life assurance policies are generally subject to the tax consequences explained in Chapter 2; however there are some special rules.

Income tax

As life policies do not produce income, the income tax rules rarely apply, but a chargeable event can occur. The current rules arise from the Finance Act 1998 and affect chargeable events occurring after 6 April 1988.

If the settlor was alive and a UK resident immediately before the chargeable event occurred, the gain is treated as part of their income. They can recover any tax paid from the trustees. If the settlor was dead or resident outside of the UK immediately before the chargeable event, and the trustees are resident in the UK, then the trustees are liable. The charge is at the rate applicable to trusts – 45% above the standard rate band and 20% otherwise. On a gain that exceeds the standard rate band there is a 25% liability for an onshore policy because of the basic rate tax credit.  No tax credit is given for offshore policies. If the trustees are not resident in the UK, any UK beneficiaries receiving a benefit under the trust from the gain will be taxable at their individual rates but without the benefit of top-slicing.

Bare or absolute trusts for minors have a special rule. Wher...

Shortened demo course. See details at foot of page.

... with reservation. Their view is that these trusts are within POAT, though in practice the £5,000 threshold will enable them to escape any tax charge as the policies are usually term assurance policies which have a negligible value.

Trusts established before 18 March 1986 as power of appointment or discretionary trusts often included the settlor as a potential beneficiary. When the gift with reservation rules were established, these trusts were given an exemption provided that their terms were not varied in a way that increased or extended benefits. This allowed contractual regular premiums to be continued without falling into the gift with reservation requirements. However, POAT contains no such exemption for such premiums and therefore the value built up since 18 March 1986 falls within the scope of the tax.

Trusts giving a temporary interest in possession to a spouse which were specifically designed to counteract the gift with reservation rules have been caught by POAT.

In its guidance of March 2005, HMRC expressed the view that POAT generally did not affect trusts used in discounted gift or loan schemes.

How are the first premiums to a life policy under trust treated for absolute and discretionary trusts?

Answer : Purchase course for answer

A large amount of investment in property is done indirectly through various other investment vehicles or wrappers. Indirect investment in property can occur through:

Special purpose vehicles for the purchase of individual development projects

Shares in listed property companies

Real estate investment trusts (REITs)

Insurance company property funds

Property unit trusts, OEICS and investment companies

Each of these methods are taxed differently, both for the company and the individual investor.

Special purpose vehicle (SPV)

A special purpose vehicle is usually a limited partnership or an exempt UK unit or investment trust, which is set up to finance specific projects. They allow investments to be made from self-invested personal pensions, small self-administered schemes and registered charities. They are usually highly geared – at up to 90% of the purchase cost – although the quality of the rental income stream from an investment grad...

Shortened demo course. See details at foot of page.

...eld through both regular and single premium policies. The value of the units in the fund is directly linked to the underlying properties in the portfolios, which are regularly professionally valued. Unlike property companies, the funds are not geared. 

Property unit trusts, OEICS and investment companies

Directly invested funds are very similar in nature to life assurance property funds, but unit trusts, OEICs and investment trusts are likely to be more tax-efficient for many investors, due to capital gains tax only arising when the gains are realised (in contrast to the rules governing life assurance policies).

The latest development in the authorised fund market has been the emergence of property security funds which invest in property companies and REITS in both the UK and overseas. This gives an element of exposure to international commercial property but is more volatile.

How do REITS have to be structured?

Answer : Purchase course for answer

The Enterprise Investment Scheme (EIS) provides tax advantages to investors in unlisted companies. To qualify as a suitable company there are certain conditions that need to be fulfilled. These are:

The company must not have assets in excess of £15 million before any investment and no more than £16 million after, and must be carrying on a qualifying trade

Generally, the company needs to have been trading for less than 7 years

The company need not trade or be resident in the UK but it must have a permanent establishment in the UK

When the EIS shares are issued, the company must be unlisted with no arrangements in place for it to become listed

When the shares are issued, the company must have fewer than 250 full-time employees (500 for knowledge intensive companies)

The company must have raised no more than £5 million under the EIS as the holding company of a venture capital trust or under the corporate venturing scheme in the 12 months ending when the shares are is...

Shortened demo course. See details at foot of page.

...r start-up companies. The main differences are:

The income tax relief is given at 50% on investments up to £200,000 per tax year

Provided they are not otherwise connected (under the 30% shareholder restriction) an investor can be a paid director at the time of investment

The company must have been trading for less than 3 years, be carrying on a new trade, have gross assets of less than £350,000 and fewer than 25 full-time equivalent employees

Where gains are reinvested, 50% of those gains are exempt from capital gains tax, and the other 50% are chargeable. The reinvestment must take place in the same tax year as the chargeable gain, or the following year.

For a higher rate taxpayer, the total relief is actually 60%, which is made up of 50% income tax relief and the equivalent of 10% capital gains tax relief (20% of 50% of a reinvested gain)

When will a capital gain which is deferred through reinvestment in EIS shares become chargeable?

Answer : Purchase course for answer

Venture Capital Trusts (VCTs) are companies which must invest in unlisted trading companies and are similar to Investment Trusts.

Investors who are aged at least 18 can obtain tax relief at the rates shown in the tax tables, for investment in newly issued shares up to £200,000 a year. The tax relief available is given as an income tax reduction, in priority to all other reliefs (similar to that for investment into Enterprise Investment Schemes).

Dividends received from investments up to the £200,00...

Shortened demo course. See details at foot of page.

...than £15 million before investment and £16 million afterwards

The company must have fewer than 250 employees. (500 in knowledge-intensive companies)

The company needs to be less than seven years old (ten for knowledge-intensive companies), but there is no age limit where the investment is at least 50% of the company’s average turnover

In which type of shares must the investment be in within a Venture Capital Trust to receive the available tax relief?

Answer : Purchase course for answer

Chapter revision test. Your results and 9.9 hours of estimated study time will be added to your CPD certificate on completion. If you retake the test then additional CPD time for the test will be added.

Multiple response question - select all the correct answers