Unit trusts and OEICs can offer a tax efficient and flexible investment vehicle which high net worth individuals and their families may wish to consider when making investment choices.
Due to the increase in capital gains tax (CGT), an authorised unit trust (AUT) or an open-ended investment company (OEIC) could be a relevant approach for wealthier families today.
An OEIC is a regulated investment structure typically used by fund managers for collective investments. There are a number of different variations, but all share some common features. OEICs are subject to additional regulations designed to protect investors; this includes limits on the types and proportions of different investments that may be held.
We refer to OEICs, although both AUTs and OEICs are included within this description.
Structure
An OEIC can act as a core investment vehicle for high net worth individuals and their families. Typically, investors could hold shares in an OEIC which meets their key investment aims, sometimes with other investments actively managed alongside it to ensure that each person's specific investment objectives are met. The unique ability of an OEIC to pool like-minded investors' funds can mean that investment management costs are spread and reporting requirements simplified.
The fund
OEICs can be based in the UK or other jurisdictions, such as Ireland, where the rules can differ. Investors should consult their tax adviser as to the relative merits of both bases. Each OEIC can either be a standalone or umbrella fund and can appoint its own investment manager or managers. This investment manager may be different to an investor's existing adviser, although this doesn't have to be the case. Shares can be bought or sold thus providing liquidity and flexibility to investors. Most OEICs are retail structures and open to any investor.
Tax considerations
For a UK resident and domiciled investor, gains on shares in a UK OEIC are only taxable when the shares are sold and in-built profits are taxable as gains, unlike some structures where the profit/gain may be taxed as income. Under current UK tax rules, the top rates of tax are 28% on gains and an effective rate of 36.1% (reducing to 30.6% on 6 April 2013) on dividend income.
Within the OEIC, net income is subject to corporation tax and underlying securities can be bought and sold free of CGT. This means that investors benefit from the management of their assets without suffering an immediate CGT charge, and so enabling gross reinvestment.
Unless investors have available cash to purchase shares in an OEIC, typically they will trigger a disposal in order to realise funds to do so. There may be tax implications if assets are transferred in specie.
Non-UK OEICs will have a different treatment for tax to UK authorised OEICs.
A UK OEIC is not treated as a UK situs asset for inheritance tax purposes, thereby providing an exemption for those who are not domiciled or deemed domiciled in the UK.
OEICs can have tax disadvantages for US persons.
Administration
In the UK, an OEIC is operated by an authorised corporate director (ACD). The ACD appoints one or more investment managers. Importantly, an investment manager can be removed and another appointed without having to close the structure, appoint a new ACD or create a tax liability. Investors in OEICs can have more than one manager, each looking after separate sub-funds, or even separate portfolios within a single fund.
Fees
Fees vary depending on the provider but can typically have an annual management charge (AMC) of 1.25% per annum for funds of less than £10m and 1% for funds above £10m. This management fee does not attract VAT. Total expense ratios are typically slightly higher than the AMC to reflect some further operational costs and VAT. Initial set-up costs are typically £15,000. It is usual for OEICs to be launched for sums of at least £10m.
The costs of running the funds, including managing the portfolio, can be met from the gross income generated by the investments. This compares with an individual investing in his/her own right, who will suffer income tax on dividends, with only the net amount left to meet investment fees.
There may be other investment costs borne by the fund, for example brokerage, custody fees and transaction charges.
Reporting
OEICs are required to prepare reports as prescribed by the statement of recommended practice with the final accounts including reports by the ACD, trustee/depositary and auditor. The reporting is therefore typically more detailed than investment portfolios held directly. The investment objectives and risk tolerance are included in the prospectus and can be amended if there is a change in circumstances.
Further information
Unit trusts and OEIC funds can offer a wide range of advantages to high net worth individuals and their families. However, they are not suitable for everyone and the tax treatment depends on the individual circumstances of each client and may be subject to change in future. It is important therefore to take appropriate advice before proceeding.
Any investment involves risk, the value of investments can go down as well as up and an investor may not receive back the original amount invested.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
