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My PFS - Technical news - 21/06/16

Personal Finance Society news update from 8 June to 21 June 2016 on taxation, retirement planning and investments.

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Taxation and Trusts

Investment planning



IHT claim successfully defended by financial adviser

(AF1, RO3, JO2)

A financial adviser has successfully defended a claim brought by two relatives of his now deceased client on the grounds that he failed to tell the client that any outstanding loan due from a loan trust would form part of the client's taxable estate on death.

In the case in question, the client, a Mrs Shemwell, had inherited £300,000 from her sister in April 2011. Her intention was to leave as much of this money as possible to two relatives, Claire Hartley and Tim Herring, while protecting it from inheritance tax as far as possible.
She consulted her usual financial adviser on this basis and was advised to place £175,000 (representing the unused part of her inheritance tax (IHT) nil rate band) into a discretionary trust and put the remaining £125,000 into a loan trust naming the two relatives as the only beneficiaries.

As is commonly known, under a loan trust while the capital placed in the trust would form part of her estate on death, thus being liable to IHT, any capital growth would be outside her estate and thus pass to the beneficiaries free of IHT.

After the trusts had been set up, Mrs Shemwell decided to make a new Will. She gave initial instructions to her solicitor at a meeting at her home on 21 October 2011. Her financial adviser attended the meeting, though only for a few minutes. Much of the subsequent dispute was about what was said at this meeting, and what was written on an aide-memoire by her adviser concerning the values of the trusts.

The solicitor went on to draft the Will, but had not made any enquiries about the terms or nature of the trusts and was not aware of whether the funds held on trust would pass to the two relatives directly on death. Instead, he wrote in legacies of £54,000 each for Hartley and Herring on the assumption that they would also receive £146,000 from the trusts.

Seven months later Mrs Shemwell died and Hartley and Herring were disappointed to find that the money in the loan trust would be subject to IHT after all, so they received significantly less money than they had expected.

Hartley and Herring decided to sue both the financial adviser and the solicitor practice for negligence - although their claim against the solicitor practice was settled by mediation last December.

Leeds County Court has subsequently ruled on the claim against the financial adviser. The judge dismissed the claim on the basis that the financial adviser did not have a duty of care to the claimants, as he had not been involved in the Will-making process.

However, the judge did say that the solicitor was negligent in drawing up the Will because he hadn't determined exactly what would happen to the trust assets and whether or not they would pass to the claimants on Mrs Shemwell's death. The judge concluded that relying on a short conversation and information contained in the aide-memoire was not sufficient.

While in this particular case the judge ruled in favour of the financial adviser, the case serves as an important reminder that when acting in a professional capacity it is essential to "join up all the planning." In particular, it is vital that the adviser knows what planning the client has already undertaken as this could have material implications on later financial planning strategies. In the case of trusts (particularly loan trusts), it is also important that attention is given to any implications that this might have on the client's Will provisions. This gives the financial adviser the perfect opportunity to work with the client's legal advisers - which in turn opens up more business opportunities.

Updated guidance on lasting powers of attorney

(AF1, RO3, JO2)

The Law Society (England and Wales) has issued an updated practice note on lasting powers of attorney which replaces the December 2011 version.

The practice note is aimed at solicitors who advise clients on drawing up a lasting power of attorney (LPA), and solicitors who are acting as an attorney under an LPA.

The updated guidance includes:

  • advice on assessing the donor's capacity;
  • the risk of abuse;
  • taking instructions;
  • drafting and registering an LPA; and
  • the situation regarding existing enduring powers of attorney.

Note the practice note does not deal with situations with an international element, for example, using an LPA to sell a foreign property, or a non-UK resident individual who wishes to make an LPA.

To view the practice note please click here.

Non-aggressive IHT planning

(AF1, RO3)

The proposed new DOTAS (Disclosure of Tax Avoidance Schemes) IHT Hallmark and continued anti-avoidance crusade leaves advisers well placed to plan and execute "acceptable" IHT Planning.

In the News Bulletin covering the period 27 April to 10 May we noted, in connection with the latest consultation on the proposed new DOTAS Hallmark (issued in late April), the following:

'The conditions of the revised Hallmark, both of which need to be met for an arrangement to be disclosable, are that:

  • The main purposes, or one of the main purposes, of the arrangements is to enable a person to obtain a tax advantage; and
  • The arrangements are contrived or abnormal or involve one or more contrived or abnormal steps without which a tax advantage could not be obtained

The latest consultation document provides examples of ordinary tax planning arrangements which may result in a tax advantage yet are not, in the eyes of the government, caught by the revised Hallmark because they are not contrived or abnormal (and so fail to meet the second condition). These include:

  • Straightforward, outright gifts
  • Lifetime transfers into flexible or discretionary trusts
  • Investment into assets that qualify for relief from inheritance tax; and
  • Arrangements that are within a statutory exemption - for example paying full consideration for the continued use of land or chattels that have been given away

Certain insurance-based arrangements, that could potentially be caught, are specifically excepted under the revised draft regulations. These are:

  • Loan trusts - whether discretionary or bare and whether or not there is an initial gift;
  • Discounted gift schemes - again whether discretionary or bare and whether established in conjunction with a life assurance or a capital redemption policy;
  • Flexible reversionary trusts - including arrangements where the retained rights can be varied or defeated by the trustees; and
  • Split or retained interest trusts

While we need the final regulations to be sure (consultation is open until 13th July 2016), as it stands the new IHT Hallmark would seem to leave financial planners well placed to plan and execute IHT planning strategies that their clients can have confidence:

  • will work and
  • will not require a DOTAS reference number

The first benefit is obviously essential and most of the strategies implemented by advisers have a long and impressive track record of effectiveness.

Especially since the advent of the accelerated payment notice (requiring an arrangement to have a DOTAS reference number) and the consequential payment of an effective tax deposit 'on the basis that the arrangement will fail', having a DOTAS reference number is not the best form of marketing. So the wide range of arrangements that (it seems) won't require one, is especially good news.

Against a background of continued government action against schemes that it considers aggressive and against the spirit of legislation and the intention of Parliament, IHT planning that you can be relatively certain won't be attacked, has a good track record of success and won't result in an accelerated payment notice is not to be sniffed at.

And while we're talking about effective IHT planning don't forget that the gift with reservation rules still exist and are especially effective in relation to residential property. In this case straightforward protection policies held in trust can do a wonderful job of tax effectively providing for the liability on assets that can't (for whatever reason) be gifted.

Discretionary trust taxation - A hidden tax charge?

(AF1, RO3, JO2)

One unintended effect of the provisions in the Finance Bill 2016 dealing with the abolition of the tax credit on the tax pools will cause problems for discretionary trusts receiving dividend income if not put right before the Bill is enacted.

As is generally well known there was very little specific information provided by HMRC prior to the new tax year regarding the new trust rates of income tax, in particular the new dividend rate, 38.1% with effect from 6 April 2016, now set by Finance Bill 2016. It now seems that indeed too little attention was paid by the parliamentary draftsman to the implications of these changes for trusts.

The problem is with the wording of Finance Bill 2016, which deals with the abolition of the dividend tax credit, which currently has the effect of imposing a hidden tax charge for discretionary trusts distributing dividends.

Section 498 Income Tax Act 2007 sets the amount of tax that can be included in the tax pool. This sets the rate of tax that can enter the tax pool for dividend income as the nominal rate defined as 'a rate equal to the difference between the dividend trust rate and the dividend ordinary rate'. This, of course, made perfect sense for previous tax years, when the dividend tax credit (which effectively franked dividend ordinary rate for accumulated income) was not matched by an actual tax payment (until 5 April 2016).

As stated above, Finance Bill 2016 sets the dividend ordinary rate at 7.5% and at the same time abolishes the 10% dividend tax credit (available to reduce the tax liability on the dividend income until 5 April 2016).

However, as from 6 April 2016 dividends are paid without a tax credit so the trustees now have a liability at 7.5% on dividends received within the standard rate band (equivalent of the dividend ordinary rate) and 38.1% on any excess. The dividend allowance available to individual taxpayers does not apply to trusts. So even though the trustees physically pay 7.5% tax, on the current wording the 7.5% does not go into the tax pool. It is only the difference between 38.1% and 7.5%, ie only 30.6% that enters the tax pool.

This seems to be unintentional. We understand that representations have been made to the Government so hopefully this is amended when Finance Bill 2016 passes through Parliament.

If the Finance Bill were to remain in its original form, the effect would be an additional tax charge for trusts paying the dividend trust rate, ie primarily discretionary trusts. Not only unintended, that would surely go against all logic as it would deny a tax credit for tax actually paid. Let us hope that common sense and logic prevail. In the meantime there is some confusion in the professional press, with some assuming that this extra tax is a fait accompli, and others ignoring the current Finance Bill wording on the grounds that an amendment is certain.

Offshore funds and spousal transfers

(AF4, RO2, FA7, CF2)

We had the question posed recently as to what the income tax and capital gains tax implications would be on a transfer of shares/units in an offshore non-reporting fund between spouses, particularly in respect of any offshore income gain.


For UK tax purposes offshore funds can be broadly split into 'reporting' funds and 'non-reporting' funds.  Their main features are as follows:-

Reporting funds

A reporting fund is taxed in much the same way as a UK unit trust/OEIC so any income that arises, whether distributed or accumulated, is subject to income tax on the investor and any gains are subject to capital gains tax.   When shares/units are transferred between spouses/civil partners living together, as defined in section 1011 Income Tax Act 2007, then the transfer is said to be on a 'no gain, no loss' basis so the transferee spouse acquires the shares/units at the transferor's base cost.  Capital gains tax is therefore deferred until sale by the transferee spouse.  There are no income tax implications on transfer. 

Non-reporting funds

A non-reporting fund is one that does not have reporting status.  The assets of the fund do not produce any taxable income subject to income tax, or capital gains subject to capital gains tax, in the hands of the investor.  Instead, generally all income and capital gains arising from investments underlying the fund will be accumulated to increase the value of the shares/units.  For this reason taxation of the investment is deferred until a disposal is made.

(a) Income tax - general

When an investor disposes of shares in the fund then there will be a disposal of the shares/units for the purposes of income tax if the disposal ranks as a disposal for the purposes of the Taxation of Chargeable Gains Act 1992.  Any gain arising is known as an 'offshore income gain' (OIG). The gain will be calculated based on capital gains tax principles but with two important differences.

(i) The capital gains tax annual exempt amount is not available to offset against the gain.

(ii) Death is a chargeable occasion.  This means that an OIG can arise on the death of an investor as a disposal is then deemed to take place for income tax purposes.  However, there will be no disposal for capital gains tax purposes.

As stated above, despite using capital gains tax principles to calculate the gain, it will be charged to income tax.  If the calculation gives rise to a loss it counts as a nil OIG.  For income tax purposes, no loss arises although the loss may be treated as a loss for capital gains tax purposes. 

(b) Capital gains tax - general

In addition to the income tax calculation, a capital gains tax calculation also has to be carried out.  Any OIG subject to income tax is deducted from the proceeds for capital gains tax purposes which means, in most cases, that there will be no gain subject to capital gains tax and a loss may arise.

(c) Gifting of shares/units to a spouse

When shares/units of a non-reporting fund are gifted, whether a gain arises depends substantially on the relationship of the donee to the donor. As stated above, where the gift is to someone other than the donor's spouse/civil partner, the disposal is deemed to have taken place at full market value and the OIG can be calculated by deducting the cost.

On the other hand, if the donee is the donor's spouse/civil partner, and the spouses/civil partners are living together, the disposal will not be one that gives rise to an OIG.  This is because under the capital gains tax rules the donee spouse will be deemed to acquire the non-reporting fund holding at the donor's acquisition cost under the 'no loss, no gain' principle.  Any gain is, in effect, held over to the donee. 

On subsequent disposal by the donee spouse (otherwise than on a disposal back to the donee's spouse), any gain will be calculated by reference to the difference between the disposal proceeds and the value of the investment when the donor acquired it (and not when the donee acquired it).  Any gain would be an OIG and subject to the rules described above. 

The fundamental tax planning quality of a non-reporting fund is that a personal tax liability can be deferred until actual encashment of the shares/units.  The deferral period can be extended tax effectively by transfers between spouses/civil partners.  This may also enable the receiving spouse to use his/her personal allowance and/or lower rates of income tax to offset against the taxable OIG.


The March of negative yields continues

(AF4, RO2, FA7, CF2)

As if to coincide with the launch of "Alice Through the Looking Glass", negative yields have continued to spread through the global fixed interest markets.

In the News Bulletin covering the period 2 March to 15 March we commented on the spread of negative yields around the world. At the time Japan had just issued 10-year government bonds with a yield of -0.024% and we raised the question of who would buy such bonds offering a guaranteed long-term loss. The answer is given in the table below - a canny trader. Japanese 10-year government bonds now yield -0.17%, so there was a profit to be made by investing back in March.


In May the stock of global sovereign debt with negative yields surpassed €10 trillion for the first time, according to Fitch Ratings. Japan, the biggest G7 debtor, had the largest share and there were 14 countries with negative government bond yields. Switzerland's longest dated government bonds, with 21 years until redemption, are in negative yield territory. Two weeks ago it was reported that the Swiss National Bank plans to sell a 13-year bond with a 0% coupon.

Two weeks ago also saw the European Central Bank (ECB) kick off the next stage of its quantitative easing programme with initial purchases of corporate, as opposed to government, bonds. The promise of such a committed buyer has already pushed the market weighted average yield on euro-denominated corporate bonds below 1%, near record lows. It has also encouraged issues of "Reverse Yankees" - US corporates, such as Johnson & Johnson, issuing euro-denominated bonds as a source of cheap financing.

How much lower can yields go? There is no experience on which to base such an answer and, not so long ago, even the idea of negative yields would have seemed delusional. One interesting straw in the wind is a recent Reuters report that Commerzbank, one of Germany's biggest banks, is examining the practicalities of hoarding cash in its vaults rather than making deposits with the ECB that earn -0.4%. This raises a variety of difficult questions, not least how to insure and transport large volumes of paper money (€1bn in €200 notes weighs about 5.5 tonnes).

So far the UK and sterling have not been touched by negative yields, although sterling has been weakening. As the table shows, even though UK government bond rates are at historic lows, gilt yields are relatively attractive for euro and yen investors. Nevertheless, UK rates have fallen since the start of the year as the spectre of US rate rises has receded. If, as press comments suggest, the Bank of England is looking to cut rates in the event of a Brexit vote, it has plenty of scope to do so before gilt yields hit (ironically) European levels.


Updated HMRC guidance issued on RAS reclaims and the SRIT

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

HMRC has issued updated guidance on the operation of relief at source reclaims, the Scottish Rate of Income tax and the 5 April 2018 deadline.

The HMRC guidance for pension scheme administrators operating relief at source (RAS) tax reclaims has been updated to reflect the two-year easement for RAS claims at the rest of the UK basic rate and not the Scottish Rate of Income Tax (SRIT) until April 2018.

The easement currently means, irrespective of there being any difference in the SRIT with that of the UK basic rate of income tax, scheme administrators can make their RAS claims on the basis of the UK rate up until 5 April 2018. Prior to 6 April 2018, HMRC will make any adjustments that might be needed will be made by HMRC through the individual's Self-Assessment return or through their PAYE coding.

However, from 6 April 2018, scheme administrators and pension providers will have to make changes to their IT systems and be able to identify "Scottish taxpayers" so as to enable them to claim RAS at the correct rate.

P.O. Announces new approach to published decisions

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

Pensions Ombudsman Service has recently announced new approach to published decisions whereby they will also publish certain adjudicators opinions.

The Pensions Ombudsman Service has announced that it has begun to publish opinions issued by its adjudicators as well as formal Ombudsman determinations.

Opinions will be published on the Pensions Ombudsman Service website if they are appealed to the Ombudsman or Deputy Ombudsman or are considered to be of interest. The Ombudsman Service has also introduced anonymisation for all new published decisions, meaning that the names of complainants and any other identifying personal data will generally be removed.

Claire Ryan, Legal Director at the Pensions Ombudsman Service, said: "The publication of a wider range of our decisions reinforces our intention to be open, transparent and accountable to the public. Our new policy on anonymisation reflects the prevailing approach of dispute handling schemes towards increased protection of personal information, while maintaining transparency in demonstrating our work and findings and giving guidance to the industry and consumers."

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