Neil MacGillivray, head of technical support at James Hay Partnership, examines the tax implications for a client when adviser charges are facilitated by a provider.
Under the Retail Distribution Review (RDR) the client has two choices when it comes to paying adviser charges: they can settle adviser charges directly or the product/investment provider can facilitate them.
Where adviser charges are being taken from the product, it is important the adviser fully understands the impact this has on its tax efficiency and investment performance.
There will be no tax implications where adviser charges are settled from cash unless the client has to sell assets to generate the cash. Adviser charges settled from stocks and shares will be a disposal for capital gains tax purposes.
Navigating the adviser charging tax minefield
This may be attractive where the client’s annual exemption is not being used. But care should be taken so as to not exceed the annual exemption of £10,600. A higher rate taxpayer will pay tax of 28% on any gain where their annual exemption is exceeded.
It is worth remembering that, where the client might exceed their annual exemption, they could sell an investment that has made a loss so that this can be offset against their other chargeable gains.
Adviser charges taken from an investment bond will count towards the 5% tax deferred allowance. To avoid a chargeable event gain, the 5% allowance should not be exceeded.
Care should be taken where both adviser charges and an ‘income’ for the client are being taken from the bond. How the adviser charge is determined, a fixed amount or a percentage linked to value will also need to be considered.
Another point worth noting is that sufficient cash within the bond will be required otherwise other underlying funds will need to be encashed, perhaps at a time when market conditions are not favourable.
It is important that ISA contribution allowances are maximised. A withdrawal from a cash ISA cannot be replenished if the maximum contribution has already been made. A disposal of stocks and shares held under an ISA will be exempt from capital gains tax; however, settling adviser charges from here would reduce the amount that could be held in this tax advantaged environment where the maximum has already been contributed.
When it comes to trusts, adviser charging throws up a number of issues. This largely springs from the fact a trust comprises a number of different parties: a settlor, trustee and beneficiary.
Of paramount importance is being clear on who is receiving and benefiting from the advice as they are ultimately responsible for paying for it. It may be necessary to split an adviser charge where it is clear that more than one party has received advice.
The settlor will be the client in most instances when advising setting up the trust, say as part of inheritance tax planning (IHT). Adviser charges relating to advice given on the investment of trust monies, ongoing investment reviews, tax and distribution should, however, be settled by the trustees.
Trustees should not use their funds to pay for advice relating to the settlor’s personal affairs. This could compromise the terms of the trust. Usually a settlor will not be a trust beneficiary to avoid the IHT gift with reservation rules. If the trustees settle advice charges relating to the settlor then the settlor is indirectly benefiting from the trust and could infringe the gift with reservation rules.
Different tax issues can arise where the settlor pays an adviser charge from their own personal funds but which relates to advice given to the trustees. It could be argued that the settlor is making a further gift to the trustees which will be a transfer of value for IHT purposes.
In short, the settlor should not pay for advice given to the trustees and the trustees should not pay for advice given to the settlor. Where adviser charges are taken from trust-held assets it will be important to know who is responsible for any tax liability that arises from doing so.
One final word on trusts. As already mentioned, the terms of the trust must be known and adhered to so as not to jeopardise the tax effectiveness of the arrangement. Discounted gift trusts are commonly used with investment bonds. Though not always, the settlor will frequently receive an income of 5% of the bond premium for up to 20 years. Where this is the case it will not be possible to settle adviser charges from the bond held under trust without contravening the terms of the trust and triggering a chargeable event.
Investment and platform providers have a number of solutions to take adviser charges from products where the client does not wish to pay them directly.
Advisers should be aware of the tax implications of doing so and ensure their client is not left with a surprise and unwanted tax bill.
>> Find out more
For more on adviser charging click here
Spent 56 years at Schroders
Warns on profits
Hargreave Hale seeking legal advice
Latest news and analysis