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My PFS - Technical news - 07/06/16

Personal Finance Society news update from 25 May to 7 June 2016 on taxation, retirement planning and investments.

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Taxation and Trusts

Investment planning



Gains on life assurance policies and the personal savings allowance

(AF1, AF2, JO3, RO3)

The personal savings allowance covers savings income. Although mostly thought of in terms of interest, savings income also includes chargeable event gains on life assurance policies. The focus here has been on offshore investment bonds and some press coverage has highlighted this. However, the legislation covering life assurance policyholder taxation (Chapter 9 ITTOIA 2005) makes little differentiation between onshore and offshore bonds, other than adding in a basic rate tax charge for certain offshore life assurance contracts (section 531 ITTOIA 2005).

All of which raised an interesting question recently. If an individual has UK interest and a chargeable event gain on a UK life policy, which benefits first from the personal savings allowance? Clearly, the preference would be for the interest to take priority as the basic rate tax deemed paid on a UK life policy chargeable event gain is not recoverable.

The answer is to be found in section 465A ITTOIA 2005, which states that if the taxable amount received is treated as having irrecoverable basic rate income tax paid - section 530 ITTOIA 2005 - then this amount is treated as 'the highest part of the individual's total income'. As a consequence, interest will take priority for the personal savings allowance. This proviso does not apply for gains on offshore policies as there is no deemed tax paid.

The legislation works in the most favourable way, but it remains a fact that some investors will effectively pay tax on interest via a life assurance policy which they could otherwise avoid by choosing a different tax wrapper.   

Annual payments do not count towards the personal savings allowance

(AF1, AF2, JO3, RO3)

Rewards paid by banks are deemed by HMRC to be annual payments which means that the payment is fully taxable and will not benefit from the personal savings allowance.

The new personal savings allowance, introduced in the 2015 Budget and applicable from April 2016, enables basic rate taxpayers to earn up to £1,000 a year tax free on their savings income. Higher rate taxpayers will be able to earn up to £500 a year tax free on their savings income.   However, additional rate taxpayers will not benefit from this allowance.

Savings income for these purposes includes

  • interest on bank and building society accounts
  • interest on accounts with providers like credit unions or National Savings and Investments
  • interest distributions (but not dividend distributions) from authorised unit trusts, open-ended investment companies and investment trusts
  • income from government or company bonds
  • the interest element of purchased life annuity payments
  • gains from certain contracts of life assurance 

However, in the context of a bank or building society account, it has emerged that the income is only tax free under the personal savings allowance if it is classified as an interest payment. A fixed monthly income paid by way of a reward is classed as an annual payment rather than interest, which makes the payment fully taxable and not capable of benefiting from the personal savings allowance.

These annual payments are effectively fixed rewards for putting the money on deposit in the first place and are commonly offered by Halifax, Barclays and Co-op Banks.

HMRC stated: 'Annual payments are not covered by the personal savings allowance, so banks and building societies will continue to pay them after basic-rate tax has been deducted.'

It will, however, be possible for non-taxpayers to reclaim the 20% tax deducted at source on these payments by completing form R40.

Note these changes do not affect those who receive interest for maintaining a certain balance in their account. For example, Santander pays between 1% and 3% interest on account balances up to £20,000. In this case the amount is paid out without deduction of tax at source and the individual will owe income tax if the amount exceeds their personal savings allowance.

Interestingly, these changes may provide an opportunity to discuss the position with clients as some may wish to consider transferring their bank account to another provider where only interest is paid on the amount deposited to ensure that such payments are covered by their personal savings allowance.

Beneficiaries' right to information

(AF1, RO3, JO2)

The recent case of Blades v (1)Isaac & (2)Alexander (2016) provides a good summary of when a beneficiary has a right to information but also confirms that, even if the beneficiary is right, costs may be awarded to be paid out of the trust fund so that any victory in the Court may prove to be expensive for the beneficiary.

The trustees in this case were partners in the firm of solicitors which drew up the deceased's Will.  Under the Will the deceased left her entire estate on discretionary trust. The claimant in the case was the daughter of the deceased and one of the beneficiaries. The trustees had power to add further beneficiaries and the deceased left the trustees a letter of wishes suggesting the trustees should consider giving 5% of the estate to another daughter of the deceased, sister of the claimant.  The trustees duly exercised their power and added the sister to the class of beneficiaries and distributed some assets to both sisters.

The claimant asked the trustees for the breakdown of the estate and the trustees refused on the grounds that they had concerns about the relationship between the sisters.  The refusal was supported by a barrister's opinion although the trustees had refused to disclose a copy of the opinion as well.  A different barrister subsequently advised the trustees that the information should be provided and in the end they provided it. This litigation therefore related only to the liability for costs.  The claimant argued that the trustees should pay all the costs, i.e. her costs and theirs, from their personal funds.  The trustees argued that all the costs should be paid out of the trust.

The judge decided that the barristers' opinions were obtained for the benefit of the trust and not for the trustees personally. Therefore, the opinions were trust documents and potentially available to the beneficiaries and so the costs of obtaining the opinions should be charged to the trust fund.  The judge also confirmed that the trustees had breached a duty to account to a beneficiary by refusing to disclose the documents to begin with, but that no loss had been caused by this and that, in due course, the trustees did act properly.  As such the Court decided it was not appropriate to charge the trustees personally with the costs. 

Generally speaking, an indemnity clause would be included in a trust deed so that the trustees would be able to recover their own costs from the trust fund in similar circumstances provided there was no misconduct and the trustees had always intended to act in the best interests of the beneficiaries.  The position in this case could also have been different if the trustees did not seek expert advice and act upon it.

The case also illustrates the potentially very serious financial implications of any kind of litigation.  Advisers should bear such potential problems in mind when advising their clients on the choice of trustees.  Ideally, the settlor or the testator will leave the trustees with a comprehensive letter of wishes, also explaining the reasons behind their decisions. Subsequent disclosure and frank discussion between the trustees and beneficiaries should help to avoid disagreements and litigation. 

Tax evasion, money laundering and confiscation measures announced as part of the Queen's Speech

(AF1, RO3)

The new corporate criminal offence of failing to prevent the facilitation of tax evasion will be introduced in the current Parliamentary session as part of the Criminal Finances Bill.

The Bill, which was announced in the Queen's Speech, will also include tighter money laundering controls and civil powers to recover the alleged proceeds of crime.

The facilitation of tax evasion offence is currently the subject of a second consultation by HMRC and is open until 10 July.

The money laundering and confiscation measures to be included in the Bill are expected to be based on the Home Office's new anti-money laundering strategy which will require those who file suspicious activity reports to supply further customer information to law enforcement agencies.

A new confiscation measure may also allow the issue of 'unexplained wealth orders' requiring individuals to declare the source of their wealth or forfeit their assets where their answers are unsatisfactory, with an associated seizure power for law enforcement agencies.

While there are no details of the Bill's measures available as yet, the government's view is that these changes will 'cement the UK's leading role in the fight against international corruption, crack down on money laundering and people profiting from crime, so that we root out corruption.'


Property valuation bases start to change

(RO2, AF4, CF2, FA7)

Several large commercial property funds have changed their valuation basis.

The February Investment Association (IA) statistics revealed a net retail outflow for the property sector of £119m, the biggest loss since the doom-laden days of November 2008. The March figures recorded a further net retail of £20m, although it is worth noting that this is the difference between two much larger numbers: an inflow of £662m and an outflow of £682m.

The recent pattern of outflows has prompted several of the big-name direct property funds to switch from an offer valuation basis to a bid valuation basis. The net effect is to wipe 5% or thereabouts off the fund price instantly, a move which shows up very clearly in the performance graphs. The bulk of the drop is explained by SDLT: an offer valuation takes account of buying costs, which include nearly 5% SDLT following the hike in the last Budget, but a bid valuation does not.

There is no suggestion that any funds will start to impose moratoria on redemptions. The latest data points to the valuation changers having adequate liquidity to cope with the current rate of outflow.

The picture could alter after the Brexit vote, which has been having a chilling effect on the property market. The latest quarterly figures from MSCI show values dropping by 0.1% in the first three "wait-and-see" months of 2016, although some of this would have been due to the SDLT increase. The overall return across the quarter was still +1.1%, a reminder of the relatively high level of rental yields compared with the returns on offer from gilts. 

The move to a bid valuation is a one-off event: if confidence returns and funds start to experience inflows again, then the process could be reversed as quickly as it happened. On the other hand, if the sector continues to be out of favour, more funds are likely to switch to a bid valuation basis.  

REITS report

(RO2, AF4, CF2, FA7)

Recently Land Securities (LAND) and British Land (BLND), the UK's two largest real estate investment trusts (REITs), reported their annual results to 31 March 2016. Both REITs suffered in the wake of the financial crisis and were forced to raise around £750m each to bolster their balance sheets in early 2009. They are in much better health now:

  • Both companies increased their annual dividend and promised higher dividends in the coming year. LAND raised its dividend by 9.9%, while BLND's increase was a more modest 2.5%. Prospective yields are 2.9% for LAND and 3.9% for BLND.
  • Net Asset Value (NAV), a key measure for REITs, rose by 10.4% at LAND and 10.9% at BLND, using a common European Public Real Estate Association (EPRA) basis.
  • Both companies reduced their loan to value ratio, an indication of a less aggressive investment approach. LAND's fell from 28.5% to 22% while BLND's dropped by 3% to 32%.
  • LAND made £1,493m of disposals in the year, but spent only £497m on acquisitions, development and refurbishment. The figures for BLND were just about in balance, with an overall net investment of just £21m.
  • On future developments both companies sounded a note of caution. LAND said it was happy with the suggestion from some commentators that its "current market positioning is more prudent than exciting". Similarly, BLND wheeled out some fine jargon in noting its "modest committed development, but a significant pipeline with optionality". Both REITs expressed concerns about the potential impact of a Brexit vote on their business.

After the trauma of the financial crisis, both LAND and BLND are taking a relatively cautious stance following the past few years' run of solid commercial property market returns. It is an indicator of investors' caution that LAND is trading at a 20% discount to NAV and BLND at 19%. At such levels of discount there have been suggestions that either company could be taken over as a cheap way of acquiring top quality property assets.

Get ready, June is here

(RO2, AF4, CF2, FA7)

It may not have felt like it over the Bank Holiday, but the meteorological start of summer has taken place. The chill winds (if not turbulence) some of the country has just experienced could well be replicated in the investment markets. The June calendar says it all:

2 June The European Central Bank (ECB) had its official rate setting meeting. It came as the ECB starts the next stage of the €80bn a month quantitative easing programme with its first purchases of corporate bonds. Although May Eurozone inflation was -0.1%, Mario Draghi, the Bank's chief, is not expected to announce any further easing of monetary policy. Instead, the market will be looking more for hints of what the next moves might be.

3 June US non-farm payroll figures were issued. These volatile numbers, often subject to significant revisions, received even greater scrutiny than usual because of the next event on this list.

14-15 June The US Federal Reserve Open Markets Committee (FOMC) will meet to set rates. Several members of the FOMC, including its chair Janet Yellen, have been dropping strong hints that they believe June will be an appropriate time to increase interest rates again. The stance of officials in recent weeks has caught the markets by surprise as earlier in May futures prices had implied very little likelihood of a rate hike: the odds are now 28%. One major question mark over whether the FOMC will jump in June or wait for the following meeting on 26-27 July is the next event on this list.

23 June  The Brexit vote has placed many investment decisions on hold. The latest odds from the bookies are 4:1 on for Remain and 4:1 against for Leave. The opinion polls resemble a random walk between the two, with the gap generally smaller than the 12%-ish 'undecided' figure. The potential market impact of the vote has been underlined by the news that hedge funds and banks are commissioning exit polls in the hope of gaining an edge. 

By the time July arrives, we may all be in need of a holiday…if we can afford one.


Scheme pays: The money purchase and/or the tapered annual allowance

(AF3, FA2, RO4, RO8, JO5, CF4)

This article considers how "scheme pays" works in respect of an individual who is subject to either the money purchase annual allowance (MPAA) or the tapered annual allowance.

Requirements for Scheme Pays

For an individual to be able to require their scheme administrator they must meet the following two conditions are met:

  1. their annual allowance charge liability for the tax year has exceeded £2,000 and
  2. their pension input amount (PIA) for the pension scheme for the same tax year has exceeded the annual allowance amount in section 228 Finance Act 2004; £40,000 for 2016/17.

However, it is important to understand how these conditions interact with the MPAA and the tapered annual allowance.

Condition 1

Where an individual's annual allowance charge liability is by reference to the money purchase annual allowance, the individual cannot elect to notify the scheme administrator unless the individual's annual allowance charge liability by reference to the annual allowance would have exceeded £2,000.

Condition 2

Where an individual's PIA to a scheme has to be more than £40,000 in the year, this is still the case even where an individual is subject to the tapered annual allowance or the MPAA.

Earmarking orders and pensions flexibility

On occasion we get asked to comment about the impact of pension flexibility on an Earmarking or Attachment order in relation to a divorce.

Earmarking or Attachment orders were the forerunner to pension sharing and was the only option (other than offsetting) prior to the Welfare Reform and Pensions Act 1999.

Earmarking orders were typically drafted to make a lump sum payment or pay a percentage of income to the ex-spouse when the pension is in payment. The flaw in the system was that the decision when to draw benefits was at the discretion of the member (unless it was specified in the Order, which was rare) so if the divorce was acrimonious, the member could delay drawing the pension or not draw it at all. Earmarking orders ceased on the members death or remarriage of the ex-spouse.

Earmarking Orders were drafted at a time when pension freedoms and flexibility was never envisaged and these new freedoms, such as drawling a UFPLS or nil income from flexi access drawdown fund, can have the unintended consequences of circumventing the requirements set out in the order, unless the details in the order are very specific.

For example, the member with the pension may be able to avoid the payment of the income as set out in the earmarking order. This could be done by choosing to take all benefits as an UFPLS. If the earmarking order doesn't specify exactly when and how benefits must be taken, and/or doesn't specify "tax-free lump" or "PCLS", the order can be circumvented by taking the UFPLS (which doesn't pay a PCLS). Then, if there are no pension funds left to crystallise, there's no income left to be covered by an income earmarking order.

In Consultation Paper 15/30, Pension Reforms; proposed changes to rules and guidance (October 2015), the FCA are consulting on the issues around pension attaching/earmarking orders, further information on the outcome of this consultation will follow in due course.

It is worth revisiting clients who have Earmarking Orders and if necessary return to the Court to get the Orders' intention clarified. There are no time restrictions on returning to Court although it will incur some expenses but that could be very worthwhile in the long run for the ex-spouse. 

Australian Government imposes cap on pension transfers

(AF3, FA2, RO4, RO8, JO5, CF4)

The Australian Government announced on 3rd May 2016 that they were introducing a new lifetime cap of $500,000 on non-concessional contributions and the cap commenced on at 7.30pm on 3 May 2016. The cap will be indexed to average weekly ordinary time earnings.

Non concessional contributions are contributions which are made after tax has been paid on the income so for example making a pension contribution from the proceeds of a house sale or investment. A pension transfer is classed as a non-concessional contribution.

What makes matters more interesting is that all non-concessional contributions made from 1 July 2007 are taken into account for the purposes of this cap. So if clients had transferred funds to a QROPS, of a value greater than the cap, then they will have already used up their cap. Transfers/non concessional contributions made before the announcement on 3rd May will not attract a penalty. Those that breach the cap going forward will be liable to penalty taxes of 45% on the excess or are being asked to remove the excess and returned to the source. That could prove interesting for UK pension schemes that have transferred funds to an Australian QROPS.

The major attraction of transferring a pension to Australia is that you can withdraw your Australian superannuation tax-free when you reach age 60. This includes any UK pension monies that you have transferred into your Australian superannuation scheme - however, this advantage has been seriously diminished with the new cap.

Queens speech: A new pensions bill

(AF3, FA2, RO4, RO8, JO5, CF4)

Although the Queens speech did not specifically refer to the pensions bill, it was announced in the accompanying notes to the speech. 

The purpose of the Bill is to:

  • Providing essential protections for people in Master Trusts - multi-employer pension schemes often provided by external organisations.
  • Removing barriers for consumers who want to access their pension savings flexibly.
  • Restructuring the delivery of financial guidance to consumers.

The main benefits of the Bill would be:

  • Providing better protections for members in Master Trust pension schemes - including millions of automatically enrolled savers.
  • Capping early exit charges to ensure that excessive charges do not prevent occupational scheme members from taking advantage of pension freedoms.
  • Providing more targeted support for consumers by restructuring the delivery of public financial guidance through the creation of two new bodies and directing more funding to the front line.
  • This helps deliver the manifesto pledge to give you the freedom to invest and spend your pension however you like.

The main elements of the Bill are:

Master Trusts

  • Master Trusts would have to demonstrate that schemes meet strict new criteria before entering the market and taking money from employers or members.
  • Creating greater powers for the Pensions Regulator to authorise and supervise these schemes and take action when necessary.

Cap on early exit charges

  • Capping early exit fees charged by trust-based occupational pension schemes.
  • Creating a system that enables consumers to access pension freedoms without unreasonable barriers.

Restructuring financial guidance

  • A new pensions guidance body would be created, bring together the Pensions Advisory Service, Pension Wise and the pensions services offered by the Money Advice Service, providing access to a straightforward private pensions guidance service for customers.
  • A new money guidance body would replace the Money Advice Service and be charged with identifying gaps in the financial guidance market to make sure consumers can access high quality debt and money guidance.

The Bill deals with the restructuring of financial guidance as announced in Budget 2016 and should deal with the concerns raised by the Work & Pensions Committee on the lack of regulation on master trusts.

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