Unit Rebates recieved by IIP trust

I have a qualifying IIP trust that has invested recently in some income generating mutual funds. Each month the platform calculates the rebate due in relation to these funds and pays the amount into a specific cash account called the Rebate Account. Because cash rebates are no longer allowed, when the Rebate Account reaches a certain level the cash is then used to purchase new units in the funds and these appear on statements as ‘unit rebates’. The ‘cash rebates’ (as opposed to the unit rebates) are subject to income tax deducted at source. Thus the Rebate Account shows cash going in, income tax being deducted on that cash and then cash being used to purchase new units.

I am unclear as to how these rebates need to be accounted for in the IIP trust accounts. The platform service advises that the rebates are payments back to the investor as part of the cost of investing based on the agreement between the fund manager and the platform/adviser and are thus capital. However, HMRC is saying they are effectively commission being passed on and thus income.

If income, there is the problem that the platform is using the life tenant’s rebate income to purchase units on behalf of the life tenant and mixing them in with the rest of the trust fund and all the issues that stem from that.

If capital, then presumably the life tenant needs to be given capital cash to match the ‘cash rebate’ amount they are being taxed on? And, presumably the base cost of the new units purchased would be the amount of cash rebate used to fund the purchase? Or would these be treated as a bonus issue? And, indeed should the cash rebate be used to reduce the base cost of the initial investments in the fund?? Or possibly not because cash rebates are not in fact allowed!

Colette Gill

Firstly you have to determine what you are receiving back - is it income or capital. What it represents is the commission that used to be paid to stockbrokers/IFAs from the fund’s annual charges - these annual charges are made by the fund to manage the investments, so I would argue they are capital in a trust context.

That being so, the rebate amount is deducted from the cost of the investment, then added back in when new units are purchased - net of the tax.

HMRC tax it to income tax as they say it is an annual payment. However, if we take the analysis it is capital, then it does not belong to the life tenant in any case (much like accrued interest charges), and would not be reported on the R185.

The argument it is capital is open to question - my argument above likens it to stockbrokers fees which are indeterminable between income and capital so must be charged to capital (for tax purposes), this should be similar - as the investment advisors are suggesting. Others, I’m sure, will disagree.

David Hartles
Shipleys LLP

Although conceptually the distinction between capital and income seems a simple one, in the real world it can become very complicated.

The first question is what is being rebated?

I assume that it is the Annual Management Charge, which on first sight might be considered a charge against income by virtue of its annual nature. However fund management groups may in fact take the Annual Management Charge from either capital or income or more likely split it in some fixed proportion.

The next question is how is the platform’s charge treated? As it seems likely that any rebate is obtained by virtue of using that particular platform it could be logical to offset it against that.

From a tax point of view the rebate is income as it charged to income tax. It would therefore follow that the as the money is charged to income tax any rebate invested in further units would logically add to the base cost of the portfolio for CGT purposes.

On a more practical level, would it not be possible to switch the existing holdings into a different class of units not generating a rebate? Switching between share classes in the same underlying fund should not generate a CGT liability. Where this not possible, it might still be worth switching into different funds over time.

This sort of issue is fertile ground for future disputes and even if a dispute does not actually arise it can still absorb amounts of chargeable professional time out of all proportion to sums of money involved.

Ian McKeever

Ian McKeever & Co Consulting Actuaries

I agree the initial question has to be - is this income or capital for a trust law perspective, regardless of the tax treatment - and I think I agree that it is probably capital.

The portfolio consists of several mutual funds that have been ‘stock-picked’ by the financial adviser (on the basis that they will produce an income for the life tenant whilst maintaining the capital for the capital beneficiaries) and the trustees have accepted this advice and invested the funds accordingly (so, no discretionary fund management to avoid being an FI for FATCA!).

The selected mutual funds are held and administered by an investment platform. The platform applies monthly platform charges (calculated as a percentage of the total value of investments) which are funded by the monthly sale of units.

The rebates are “payments back to the investor as part of the cost of investing in particular funds based on what’s been agreed with the fund manager”. These are paid in cash initially and credited to a Rebate Account. But, cash rebates are no longer allowed so they have to be used to buy units - which then becomes a unit rebate.

So each month, there is a sale of existing units to fund the platform charges and a purchase of units if there is sufficient cash in the Rebate Account.

HMRC’s view is that these rebates are rebates of commission because the fund manager is deducting them from business income as a business expense - so they are subject to income tax.

Looking at it (and I have asked the IFA and platform for clarification of this) it appears that the rebates are either (1) refunds of the platform charge; or (2) refunds of the underlying costs of investing (presumably taken into account in the pricing); or (3) refunds of trail commission.

If (1), then the treatment in the trust accounts would be to credit the Capital Account with the net Cash Rebate figure and then when new units are purchased, the cash rebate used to fund the purchase becomes the base cost.

If (2), then presumably the treatment would be as you say to reduce the base cost of the initial investments by the net amount when the Cash Rebate comes in - though how would I apply this across the various funds since the cash rebate isn’t broken down by fund? - and then to account for the new units as in (1)

If (3), then I have more of a headache because the beneficiary is then adding to the trust fund and I do not know if it can be separated out retrospectively

On top of all the above, there are sales every month so I will need to match the purchases against them first (30 day rule) which is making the CGT calculations very laborious. The platform does not produce CGT reports, only transaction listings - though given the issues it is probably just as well.

And, as you rightly point out, all of the above relates to some very tiny amounts.

If is frustrating because the investments appear to be doing what the trustees want them to do and if it wasn’t for these rebates, all would be good! I will investigate if they can be dropped…

Thank you for the replies. I am certain others must have come across this issue to date…

Colette Gill

Your final comment worries me. There are two questions

  1. Are these payments capital or income for tax purposes?

  2. Are the payments capital or income for trust purposes?

These are two separate world views. If these payments are income for tax purposes and capital for trust purposes, I cannot see that you can read trust interpretation into the tax world view and treat them as capital for CGT purposes unless you have very good reason to do so.

Surely from a tax viewpoint if the money is subject to income tax the units purchased are new investments and not bonus units. Equally the idea of settlor interested trusts is a tax concept. If the money is, for tax purposes, the income of the trust it seems hard to argue that it is a payment by the settlor for tax purposes, even if for trust purposes that is the interpretation you are making.

I am not sure that you can read across a trust interpretation into the tax world in the way you seem to be suggesting.

You have to do what is right for trust purposes and then put your Taxpayer hat on and view what you have done from a tax point of view. If you have retained in the trust monies for the remaindermen that is for tax purposes income, because from a trust point of view it is capital, then you must follow through the tax consequences of retaining income.

Personally, as the sums involved are small, in the short term I would make every effort to take the view that is simplest and takes up least professional time as that benefits all the beneficiaries of the trust. In the longer term it is worth getting rid of the issue by moving into investments which do not produce these messy rebates as any additional investment returns are likely to be dwarfed by the extra admin costs.

Ian McKeever

Ian McKeever & Co Consulting Actuaries