Authorised investment funds for individual investors: planning ideas

Author Image The Technical Team
7 minutes read
Last updated on 6th Apr 2019

Overview

Authorised investment funds are collective investment schemes authorised and regulated by the Financial Services Authority (FSA).

Key points

  • AIFs do not pay tax on capital gains and instead the investor is potentially liable to CGT on disposal of shares
  • Unit trusts and OEICs allow investors access to professionally managed portfolios by pooling their assets
  • They can be held by individuals, trustees and companies with a huge range to choose from allowing portfolio diversification.

How AIFs are set up legally

Authorised investment funds (AIFs) may be constituted under two different legal forms:

  • Authorised unit trusts (AUTs), and
  • Open-ended investment companies (OEICs)

An investor may therefore own units or shares in an AIF. For the remainder of this article, the terms 'unit' and 'unit holder' should be read as equally referring to 'share' and 'shareholder' in an OEIC.

As explained in Authorised Investment Funds (AIFs) for Individual Investors AIFs do not pay corporation tax on chargeable (ie capital) gains. Instead, the investor is potentially liable to capital gains tax (CGT) on disposal of shares or units.

Rates and annual exemption

The rates for CGT in 2019/20 are:

  • 10% for individuals where total taxable gains and income are less than the upper limit of the basic rate band (£37,500+£12,500 = £50,000)
  • 20% for individuals in respect of gains (or any part of gains) above that limit.

The annual exempt amount (AEA) for individuals (including children) for 2019/20 is £12,000. No claim is required for the annual exemption. Any unused exemption may not be carried forward.

The Scottish rate of income tax applies to non-savings and non-dividend income – the personal allowance and thresholds and taxes on savings and dividends remain a UK ‘reserved’ matter.

CGT has not been devolved (nor NIC, IHT or corporation tax).

Example 2019/20

Tina realises a chargeable gain of £31,000. She has taxable income of £19,385 after allowances.

Taxable gain = £19,000 (£31,000 - £12,000).
£18,115 x 10% = £1,811.5 (£18,115 = £37,500 - £19,385)
£885 x 20% = £177 (£885 = £19,000 - £18,115)

£19,000

Total CGT payable = £1,988.5

Basic principles

Chargeable gains (or allowable losses) accrue on the disposal of assets. The word 'disposal' is not expressly defined in the Taxation of Chargeable Gains Act (TCGA) 1992, so must be given its natural meaning. Sales and gifts are both examples of natural disposals. Gifts to children, for example, may therefore give rise to a CGT charge. Similarly, gifts to trustees can create a CGT liability although 'hold over relief' may be available (S260 TCGA 1992) in certain situations. This is a complex area requiring professional advice. Note however that certain disposals are no gain / no loss disposals, where the asset is treated as passing from the transferor to the transferee at a value which results in neither a gain nor a loss accruing to the transferor. For example:

  • transfers between husband and wife or between civil partners in a year of assessment in which they are living together.

The result is that the recipient will inherit the asset's CGT 'history'.

The exemption for inter-spouse transfers can be used to ensure that gains are realised by the partner with the lower marginal CGT rate.

Neither indexation allowance nor taper relief apply to disposals of assets by individuals on or after 6 April 2008.

Calculating the gain

In very broad terms a 'capital gain' is the amount by which the disposal value of a chargeable asset exceeds its acquisition value. Certain incidental costs (eg dealing fees, stamp duty reserve tax) are also deductible.

Where a chargeable asset is gifted (ie not a bargain at arm's length), the person making the gift is treated as disposing of the asset at market value, unless it is a no gain / no loss transfer.

Identifying units being sold

S99 TCGA 1992 treats units in a unit trust as though they were shares in a company. The normal CGT rules which apply to shares apply to units in a unit trust.

One feature of shares is that unless they are numbered, and most shares are not, all shares of the same class in the same company are identical. The problem this causes can be illustrated quite easily.

  • 2007 Alan buys 1,000 units at a price of £2.50 per unit - expenditure £2,500
  • 2013 Alan buys a further 500 units at £4 per unit - expenditure £2,000
  • Alan has now spent £4,500 on 1,500 units
  • 2019/20 Alan sells 250 shares for £5 each

To work out the capital gain it is necessary to know which units Alan sold and how much they cost.

Special 'share pooling' rules exist to deal with this problem.

Shares of the same class in the same company acquired at any time by a person in the same capacity will normally become part of the 'Section 104 holding'. The Section 104 holding is simply the share pool. However, shares that are identified with acquisitions under the 'same day' or 'bed and breakfasting' identification rules do not become part of the pool.

The Section 104 holding is a pool of qualifying expenditure as regards the number of shares in the holding.

The pool grows whenever further shares are acquired that enter the pool and reduces when there is a disposal of shares from the pool (shares identified in accordance with the first two bullet points below do not enter the S104 holding).

Legislation provides that disposals must be identified in the following order:

  • Against acquisitions on the same day (the 'same day rule').
  • Against acquisitions within the 30 days following the disposal (the 'bed and breakfast' rule).
  • Against shares in a Section 104 holding, but without identifying any particular shares in that holding

Applying these rules to the above example of Alan produces the following result:

Section 104 Holding - before disposal

Date

Number

Cost

Total

2007

1,000

£ 2.50

£ 2,500

2013

500

£ 4.00

£ 2,000

5 April, 2019

1,500

£ 3.00

£ 4,500

 

2019/20 CGT computation

Proceeds

250 x £ 5

£ 1,250

Cost

250 x £ 3

(£ 750)

Gain

 

£ 500

Section 104 Holding - after disposal

Date

Number

Cost

Total

5 April, 2019

1,500

£ 3.00

£4,500

Disposal

(250)

 

(£ 750)

5 April, 2020

1,250

£ 3.00

£ 3,750

Anti-avoidance rules

Matching disposals against acquisitions on the same day and against acquisitions within the 30 days following the disposal are anti-avoidance rules to counter the practice of selling and buying back shares shortly afterwards simply to realise a gain, and increase the base cost for future disposals (or simply to realise an allowable loss). This works as follows:

Example

Alison has 9,500 units in her Section 104 holding

  • 30 August 2019 - sells 4,000 units
  • 12 Sept 2019 - purchases 500 units

Her disposal of 4,000 units is identified as follows:

  • 500 against units purchased on 12 Sept 2019 under the 'bed and breakfasting' rule.

3,500 against the shares in the Section 104 holding

Planning

The 'bed & breakfasting' anti-avoidance rules do not apply in the following situations:

  • Repurchase after 30 days
  • Repurchase of a non-identical fund
  • Repurchase made by spouse

Repurchase within an ISA or pension

Losses

An individual is assessable to CGT on his or her total chargeable gains for the year of assessment reduced by:

  • allowable losses
  • the AEA.

The treatment of losses depends on whether they are:

  • losses of the same year of assessment as the gains
  • losses of earlier years of assessment.

The procedure is as follows:

1. Deduct any allowable losses accruing in the year of assessment from gains made in that same year – even if the net chargeable gains fall below the AEA (losses which cannot be set against gains of the same year of assessment are carried forward and set against gains which arise in the future).

2. If the net gains under 1. above are more than the AEA (£12,000) and there are unused losses brought forward from a previous tax year then deduct those losses, but just enough to reduce the net gains to the AEA limit.

3. If there are still unused losses from a previous year after they have reduced gains to the AEA, they can be carried forward to future years.

Example 2019/20

2018/19 - Joan made losses of £20,000 which have been carried forward.

2019/20 - Joan made gains of £25,000

  • There are no losses arising in 2019/20 to set off against the gains
  • Gains in 2019/20 exceed the AEA and therefore unused losses brought forward can be used to reduce the gains to £12,000 (£25,000 less £13,000 = £12,000)

Unused losses to be carried forward to 2020/21 and beyond = £7,000 (£20,000 less £13,000)

Planning aspects with losses

There is no point – from a tax perspective – in crystallising a loss when net gains in that same year of assessment are within the AEA.

Losses crystallised in a year of assessment in which there are no gains will allow the full amount to be carried forward.

If one spouse or civil partner has realised gains in excess of the AEA and the other spouse has uncrystallised losses, consider an exempt inter-spouse transfer followed by a disposal.

Losses in the year of death

As noted above, capital losses that can’t be used in the year of assessment in which they arise may normally only be carried forward. There is an exception however. If an individual incurs capital losses in the year in which he or she dies, those losses must first be set against gains of the same year (even if this reduces the net figure below the AEA). Any surplus can be set against gains of the three preceding years – allowed against the gains of a later year before gains of an earlier year.

© Prudential 2019