Taxation of Indirect Investments

• Topic 01

  Taxation of Indirect Investments

  27 questions

A few questions from this unit, with the answer and a full explanation. The complete bank is available when you start practising.

1. How does the 20% notional tax credit on an onshore bond affect a basic-rate taxpayer's liability on a chargeable event gain?

   • A
     A basic-rate taxpayer has no further income tax liability on the gain; the 20% notional tax credit fully extinguishes their 20% income tax liability
     Correct answer
   • B
     A basic-rate taxpayer pays 20% tax on the gain but can claim a refund of the 20% credit, resulting in a nil liability
   • C
     A basic-rate taxpayer pays 20% tax on the gain; the credit is only available to higher-rate taxpayers
   • D
     A basic-rate taxpayer pays 10% tax on the gain; the 20% credit reduces the 30% life assurance rate to 10%
   Explanation

   Onshore life bonds are held within a UK insurance company that pays corporation tax on the fund at approximately 20%. HMRC treats this as equivalent to basic-rate income tax having been paid. The investor's gain therefore carries a 20% notional tax credit. For a basic-rate taxpayer (20%), the credit exactly matches their liability — resulting in no further income tax to pay. A higher-rate taxpayer (40%) has additional liability of 40% minus 20% = 20% of the gain. An additional-rate taxpayer (45%) pays 45% minus 20% = 25% of the gain. No refund is available if the investor is a non-taxpayer or below the basic rate.

2. What is an OEIC (Open-Ended Investment Company) and how is it taxed compared to a unit trust?

   • A
     An OEIC is taxed differently from a unit trust: OEIC gains are always CGT-exempt
   • B
     An OEIC is a closed-ended fund and once all shares are issued, no new investments can be made; distributions are taxed as non-savings income
   • C
     An OEIC is a pooled investment company that can issue new shares to meet investor demand; it is taxed in the same way as a unit trust — distributions from equity OEICs are dividend income; from bond OEICs, savings income
     Correct answer
   • D
     An OEIC is similar to an investment trust (closed-ended company) and all distributions are taxed as dividends
   Explanation

   An OEIC is an open-ended collective investment structured as a company (rather than a trust), but it is economically equivalent to a unit trust and the tax treatment is identical. Distributions from equity OEICs are treated as dividend income (8.75%/33.75%/39.35% after the Dividend Allowance); distributions from bond OEICs are treated as savings income (20%/40%/45% after the PSA). Capital gains on disposal of OEIC shares are subject to CGT in the normal way. Investment trusts are different: they are closed-ended companies.

3. An investor holds 5,000 accumulation units in an equity OEIC bought for £2 per unit. Over the year, £0.10 per unit of income is rolled up. They sell the units at the end of the year for £2.10 each. What are the tax consequences?

   • A
     Income tax on £500 as savings income and CGT gain = £500 minus AEA = nil; both charges apply simultaneously
   • B
     Income tax: £0.10 × 5,000 = £500 deemed dividend income (taxable as dividend). Base cost increases to £2.10 per unit. On disposal: proceeds = £2.10 × 5,000 = £10,500; base cost = £10,500; gain = £0. No CGT
     Correct answer
   • C
     No income tax (accumulation units never trigger income tax); CGT on disposal = £0.10 × 5,000 = £500 gain
   • D
     No income tax and no CGT because the accumulation units did not increase in market value during the year
   Explanation

   Accumulation units: income is still taxable even without cash distribution. Deemed dividend income = £0.10 × 5,000 = £500. This is taxable as dividend income in the year it arises. The reinvested income increases base cost from £2 to £2.10 per unit, preventing double taxation. On disposal at £2.10: proceeds = £10,500; adjusted cost = £10,500 (5,000 × £2.10); capital gain = £0. No CGT is payable. If the base cost were not adjusted, the investor would be taxed twice on the same income.