Bonds or Collective Investments Bonds or Collective Investments? Tax and facts Part 2 – Collectives For consideration by professional advisers only Hello, my name is Cathy Russell and I’m one of Canada Life’s Tax and estate planning consultants who works within the ican Technical Services Team. This presentation is Part 2 - a brief introduction to collectives. I’m going to run through the taxation of collectives and the advantages and disadvantages, and hopefully, once you’ve watched part 1 on bonds as well, you’ll have sufficient information to demonstrate that there is no definitive answer which fits all clients. It has to be looked at on a case by case basis. If you would like any further information, please see the attached contact sheet or email us directly via the presentation link. Now onto the presentation.

Bonds v Collectives – taxation implications Income tax Investment Bonds Capital gains tax Collectives If we look at the taxation implications: Collectives are liable to Income Tax And Capital Gains Tax

Collectives - fund taxation Exempt from tax on gains UK dividends paid to investor on a regular basis All other income (rent, interest) subject to 20% tax Within the collectives fund this is exempt from any tax on gains Any UK dividends are distributed to the investor, possibly every three or six months – or accumulation units may be used so the dividends are automatically reinvested. Any other income – such as rent or interest – is subject to 20% tax

Collectives – investor taxation – income tax Variable income, taxed on an arising basis year on year This includes accumulation units! Equity collectives: No tax deducted by the collectives provider Individual investors have the £2,000 tax-free dividend allowance, thereafter : basic rate taxpayers pay 7.5% higher rate taxpayers pay 32.5% additional rate taxpayers pay 38.1% Let’s look at investor taxation – and we’ll start with income tax This is variable income which is taxed on an arising basis year on year And this does include accumulation units as well as income units. Some people wrongly assume that because they haven’t physically received the income they don’t need to declare it for tax purposes! If we look at equity collectives there is no tax deducted by the collectives provider. Individual investors can use the £2,000 tax-free dividend allowance before being liable to tax at their marginal rate: Which is 7.5% for basic rate taxpayers 32.5% for higher rate taxpayers and 38.1% for additional rate taxpayers

Collectives – investor taxation – income tax Variable income, taxed on an arising basis year on year This includes accumulation units! Corporate bond collectives: Notional tax credit of 20% on property income Reclaimable by non-taxpayers including those with unused starting rate band or personal savings allowance This meets the liability of basic rate taxpayers Higher rate taxpayers have to pay an extra 20% of grossed-up distribution Additional rate taxpayers have to pay an extra 25% of grossed-up distribution If we look at a corporate bond/fixed interest type collective these used to come with a notional tax credit of 20% but these are now paid gross for dividends/interest. However property funds will remain subject to 20%. This is reclaimable by non-taxpayers including those with unused starting rate band or personal savings allowance. The 20% notional tax credit deducted at source does meet the liability of basic rate taxpayers However higher rate taxpayers have to pay an extra 20% of the grossed-up distribution and additional rate taxpayers have to pay an additional 25% of that grossed-up distribution

Investor taxation – capital gains tax Capital profit taxed when realised Annual exemption = £11,700 for 2018/19 for individuals £5,850* for trustees Disposals: Non-taxpayers and basic rate taxpayers = 10% on gains in excess of annual exemption Higher rate taxpayers/Additional rate taxpayers/trustees/personal representatives = 20% on gains in excess of annual exemption *£5,850 split between number of trusts created by the settlor. Minimum £1,170 per trust. Moving on now to capital gains tax We all know that capital profit is taxed when realised However, every individual has an annual exemption – currently £11,700 in the 2018/19 tax year That’s for individuals, if it’s trustees of a trust they have a maximum of £5,850. I say maximum because this is shared amongst all live discretionary trusts that a settlor has in a particular year down to a minimum of one fifth – so £1,170 in the 2018/19 tax year. When we come to disposals non-taxpayers and basic rate taxpayers pay 10% on any gains in excess of the annual exemption. Higher rate taxpayers, additional rate taxpayers, trustees and personal representatives all pay 20% on any gains in excess of the annual exemption.

When is investor tax assessed? Collectives As dividends and interest are paid (or reinvested automatically) On disposals (including switching funds) if taxable gain arises When is investor tax assessed? Well on collectives it’s when any dividends or interest is paid – the tax would be assessed in the same tax year On disposals – and remember that does include switching funds – if any taxable gain arises – then the tax is also assessed in that same tax year

Income production If a client wishes to take a regular ‘income’ from his collective he could take that as a partial withdrawal of capital By using the part disposal formula………… If a client wishes to take a regular income from any collective – apart from taking any natural income which is produced he could, instead, take that as a partial withdrawal of capital by using the part disposal formula

A A + B Part disposal formula The A over A plus B formula: Purchase price x Purchase price = original investment at start of year A = value disposed B = value of remaining investment A A + B This is commonly called the A over A plus B formula. What we are going to do is to calculate how much of the withdrawal is actually original capital so that we can then determine the capital gains tax position. The purchase price is the original investment, A being the capital amount the investor is withdrawing (that is, what’s being disposed of) and B being what’s left in the investment after the withdrawal has been taken.

part original capital and part gain Part disposal formula Withdrawal includes part original capital and part gain Gain year 1 If you think of the original capital as a circle (which looks like a cake) and then each year the gain is represented by a ring around that circle, when you take a withdrawal at the end of year 1 you are getting a slice of the cake – which contains some of the original capital and some of the gain. By using this formula you can deduct the portion of original capital from the total withdrawal to determine how much gain will be set against your annual exemption. Original capital

Collective case study £400,000 investment Fund value increases by 4% pa after charges (end of year 1 £416,000) Full annual CGT exemption is available He wishes to take £15,000 at the end of year 1 £400,000 x £15,000 £15,000 + £401,000 = £14,423 (return of original capital) Therefore the gain = £15,000 - £14,423 = £577 Here’s a quick example A client invests £400,000 We’ll assume the fund grows by 4% pa after charges and he has his full CGT annual exemption available At the end of year 1 he wishes to take a £15,000 withdrawal Remember the formula was: purchase price x A over A plus B Therefore from a £15,000 withdrawal we can see that £14,423 is actually return of capital and the gain is only £577 to offset against his annual exemption of £11,700

ii) part original capital £14,423) Part disposal formula Withdrawal includes: i) part gain (£577) and ii) part original capital £14,423) Gain year 1 Note: From year 2 onwards the ‘purchase price’ is rebased. It becomes original purchase price LESS any original capital already returned. (£400,000 - £14,423 = £385,577) Coming back to our example where the withdrawal contained some original capital and some gain – we now know that the original capital returned was £14,423 and the portion relating to the gain was just £577. Remember that each year you have to rebase the purchase price by deducting the amount of capital already returned. So at the end of year 2 the purchase price would be £400,000 minus £14,423 giving you £385,577. This rebasing would need to be done every time there was a withdrawal. Original capital

Collectives: advantages Income-producing or growth-orientated Suitable for “income” trusts or where separation of income & capital is necessary Fund of funds – manage without CGT considerations Ability to use CGT exemption/part disposal formula Offset/carry forward losses CGT uplift on death Let’s look at their advantages: An obvious advantage is that they can produce income or capital appreciation, or indeed both. The client actually sees something coming out of their investment and may feel psychologically comfortable about that. Therefore if we are looking at a trust that requires income to be paid (say - to adult beneficiaries) or a situation where a separation of income and capital is required, clearly a collective could be appropriate. Some collectives are run on a fund of funds basis, whereby the fund manager is able to alter the investments when he chooses, without triggering a tax event, rather like through a life assurance contract. Therefore it is possible to professionally manage and review the portfolio without any CGT consideration, although the investor arguably loses an element of control. Ability to use the CGT annual exemption, and as I’ve just shown you, you can also use the part disposal formula, You can offset losses, or carry them forward to future years And, of course, you get the CGT uplift on death, as any CGT liability dies with the owner

Collectives: disadvantages Investment restructure is a tax event Administratively more cumbersome CGT on gains above reliefs/exemption More onerous self assessment Dividend income – complex (especially for discretionary trusts) To avoid CGT need to be non-resident for minimum of 5 years Onto the disadvantages of collectives: Although I’ve said with a fund of funds, there is the ability to re-structure an investment portfolio without taxation, if the client is actually going to swap one particular unit trust or one particular fund for another, then clearly that is a tax event which could give rise to a tax liability. In some cases, having a tax event could be seen as an advantage – if we are making sure it is within the CGT allowance, as it enables the base value to be uplifted tax-free, thus minimising any future gains. Because collectives generate income generally, and, from time to time capital gains, clearly administration becomes more cumbersome. Of course, if gains are significant, then the reliefs and exemptions could be exceeded such that a tax liability could arise. This leads to more onerous self assessment! With dividend income, the tax calculations become complex, especially for trustees of a discretionary trust that regularly distributes its dividend income to the beneficiaries. The dividend allowance is not available for distributions from a discretionary trust. To avoid capital gains tax, by moving abroad, you would have to be non-resident for 5 years

What is the purpose of the investment? Bonds v Collectives What is the purpose of the investment? Capital Growth? Income Production? IHT planning? So, in summary, when it comes to making a decision should we use bonds or collectives – Remember to look at each case on its own merits: What is the purpose of the investment? What is the client looking to achieve? What are the client’s own circumstances?

Time horizon of investment Points to consider Time horizon of investment How actively will the investment be managed? Asset allocation - income or growth funds? Have tax allowances/exemptions been used? Assumptions used for tax rates/gains/income Will the tax position of the client change? Don’t isolate tax as the sole factor when making the decision Exit strategy We need to consider the various points shown here (read from slide) And remember NOT to isolate tax as the sole factor when making your decision There are different ways to take money out of a collective portfolio – and the rate of CGT applicable does depend on other income.

Remember – bonds and collectives are different structures Bonds or Collectives? Remember – bonds and collectives are different structures Assumptions Growth or income? Objectives/tax status of investor Remember bonds and collectives are very different structures and each case should be decided on its own merits.

Your Canada Life contacts In the first instance, contact your local account manager for support on specific cases or general principles surrounding tax and estate planning for both UK and international products, including trusts. Technical Services Pre-sales: 01707 422999 Onshore existing business: 0345 6060708 Offshore existing business: 01624 820377 ican@canadalife.co.uk www.ican-canadalife.co.uk In the first instance, contact your local account manager for support on specific cases or general principles surrounding tax and estate planning for both UK and international products, including any trusts. For further information please see the attached contact sheet or email us directly via the presentation link.

Important information This presentation is for consideration by professional advisers only and is not intended for communication to the general public. It is based on Canada Life’s understanding of applicable legislation as at April 2018 which may be altered and depends on the individual financial and other circumstances of the investor. It is not intended to be tax or investment advice. Past performance is not a guide for the future. The value of units can fall as well as rise. Currency fluctuations can also affect performance. Canada Life Limited, registered in England no. 973271. Registered office: Canada Life Place, Potters Bar, Hertfordshire EN6 5BA. Telephone: 03457 226 232 Fax: 01707 646088 www.canadalife.co.uk Member of the Association of British Insurers. Canada Life International Limited, registered in the Isle of Man no. 33178. Registered office: Canada Life House, Isle of Man Business Park, Douglas, Isle of Man IM2 2QJ. Telephone: +44 (0) 1624 820200 Fax: +44 (0) 1624 820201 www.canadalife.co.uk Member of the Association of International Life Offices. Canada Life International Assurance (Ireland) DAC, registered in Ireland no. 519085. Registered office: Irish Life Centre, Lower Abbey Street, Dublin 1. Telephone: +353 1 704 1747 www.cliassurance.ie Member of the Association of International Life Offices. Canada Life Limited is authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. Canada Life International Limited and CLI Institutional Limited are Isle of Man registered companies authorised and regulated by the Isle of Man Financial Services Authority. Canada Life International Assurance (Ireland) DAC is authorised and regulated by the Central Bank of Ireland. ID5050-418R – expiry March 2021 19