This article provides a high-level summary of the potential advantages and disadvantages of using a collective investment.
There are many considerations which may influence any advice. These may include:
- Simplicity
- Price
- Access
- Risk profile
- Fund choice
- Future aspirations and objectives
- Tax
These are client specific and as such form a key part of any recommendation made.
Taxation within a collective investment
UK open-ended investment companies (OEICs) and unit trusts receive UK dividends and pay dividend distributions without having to account for corporation tax.
All other forms of income are subject to corporation tax at 20%. This could include interest, dividends from non -UK companies and rental income.
Taxation of the investor
Income tax is payable on interest and dividends arising from income and accumulation units. Income received is therefore taxed, even where reinvested, and is payable at the investor’s marginal rate of tax.
All individuals can receive £1,000 of dividends with no tax liability (reducing to £500 in tax year 2024/25) and dividends received in excess of this will be taxed at the appropriate dividend rate:
- 8.75% for basic rate taxpayers (BRTs)
- 33.75% for higher rate taxpayers (HRTs)
- 39.35% for additional rate taxpayers (ARTs)
- Non-tax payers have no further tax liability.
- For certain trusts, dividend income is also taxed at 39.35%.
Interest distributions are paid without the deduction of basic rate tax. Individuals have a personal savings allowance of either £1,000 (for basic rate tax payers) or £500 (for higher rate tax payers) where 0% is payable.
Capital gains tax
- A rate of 10% or 20% (or a mixture of both where the chargeable gain, when added to the individuals other taxable income, straddles the higher rate tax threshold) after any available annual exemption has been applied (£6,000). Unused investment losses can be carried forward indefinitely to offset against future gains, provided the losses have been registered with HMRC.
- Legal Personal Representatives also have an annual exemption of £6,000, but trustees only have half of this, ie £3,000, which is divisible by the number of trusts in existence with the same settlor to a minimum of £600 per trust.
Advantages of collective investments
- Capital gains tax (CGT) rate of 10% or 20% for all taxpayers depending on their other taxable income.
- Base cost of investment for CGT purposes is revalued on death.
- Able to use personal or trustee CGT annual exempt amount to reduce taxable gains.
- Unused losses can be carried forward indefinitely (provided that they are registered).
- Transparency of pricing.
- Can be real income-producing or growth-orientated investments.
- Can be suitable for trust investments where different beneficiaries are entitled to income or capital.
- Up to the first £1,000 of discretionary trust income in a tax year is charged at 8.75% or 20% depending on the nature of the trust income.
- Can utilise minor’s income tax and CGT allowances (income tax allowance use may be restricted to £100 in any tax year under the parental settlement rules).
- Excluded property for IHT purposes for non-UK domiciled investors.
- Fund of funds – switches within such funds will not give rise to a personal CGT liability.
- Gains realised while non-resident may not be liable to UK tax (subject to duration of non-residency).
Disadvantages of collective investments
- Fund switches can give rise to a personal CGT liability.
- Change of ownership may give rise to a CGT event (other than transfer to spouse) including to a trust.
- Share identification rules apply on switching in and out of the same funds within 30 days.
- Collectives are normally included where means testing is applied by a local authority for residential care.
- Income producing asset so possibility of annual tax returns for individuals or trustees.
- HMRC self-assessment reporting of disposals is required even where no gain is realised or the gain is less than the annual exempt amount if proceeds exceed £50,0000.
- All income received is liable to tax up to 45% as it arises, on both income and accumulation units unless covered by allowance/exemption.
- Dividend income distributed to beneficiaries from a discretionary trust is taxed as trust income, ie at the special trust rate of 45%.
- Complex part disposal calculations, for regular withdrawals.