Paul Kennedy is taxation & trusts manager (investment) at Prudential So, when is a portfolio bond n...
Paul Kennedy is taxation & trusts manager (investment) at Prudential
So, when is a portfolio bond not a personal portfolio bond? Avoiding the creation of a highly personalised bond is likely to be paramount for most UK-based clients to avoid the spectre of a draconian annual tax charge.
In his presentation, Paul Kennedy led the International Investment forum through the maze that surrounds the complex web of intertwining legislation, delineating what can and what cannot be put into a portfolio bond, without making it 'highly-personalised'.
Portfolio bonds are those contracts by which the client, in conjunction with the intermediary, selects the investments that go into the underlying bond. Lurking in the background, according to Kennedy, is a harsh piece of legislation that can cause a portfolio bond to become a highly personalised one. There is much confusion around the legislation, he said.
It is not possible to put just anything with a 'price' on it in a bond because certain investments might create a highly personal bond. Kennedy believes that a lot of confusion has come about because new investments have appeared, such as structured products and hedge funds.
To understand whether a fund transgresses the rules, we need to apply the underlying UK legislation, not legislation from abroad. The saga started unfolding eight years ago in the House of Lords when the case of Professor Willoughby was brought before the court. The case concerned the investments that he had selected in three offshore bonds. The Inland Revenue was trying to tax the bonds under general anti-avoidance legislation but lost their case.
Following its defeat, the Revenue introduced specific legislation in the UK in 1999, the Personal Portfolio Bond Regulations, which were targeted at what are colloquially known as highly personalised bonds. However, the regulations are intertwined with a whole host of other rules outlining what can and cannot be done, and this is where some of the confusion arises.
Kennedy reminded the forum that if a portfolio bond creates a highly personalised bond, the investor will be subject to an annual tax charge of a deemed gain of 15%pa compound. It does not matter what the actual underlying performance is, the legislation assumes a gain each year of 15%, which will be taxed accordingly each year for UK residents.
According to Kennedy, three hurdles must be overcome before a bond becomes highly personalised. The first is that the policyholder must be able to select or have the ability to select the investments. The second is that the investments selected must fall outside the range of permitted investments. The third and final hurdle is that the investment in question should not just be available to that policyholder but to a whole class of policyholders.
Even where a discretionary asset manager is used, if the mandate is too explicit or restrictive this could be viewed by the Revenue, in some instances, as effective policyholder selection. In relation to the second hurdle, Kennedy pointed out that there are broadly five categories of investments: internal linked funds, cash deposits, collective investments, other insurance contracts and indices. If the type of investment being used is not on this list, then it will become a highly personalised bond.
Kennedy gave the example of cash deposits to highlight some of these issues. An investor is not allowed to invest in cash if they are doing so to realise a gain from the disposal of cash. If investing in cash to speculate on currency movements to make a profit, that will bring about a highly personalised bond.
Kennedy said: "There is a subjective notion of what is the investor trying to do. If the investor is trying to get a gain, then it is a highly personalised bond, so the investor will have a problem with anything other than sterling deposits, if gain is the motive."
However, he thinks the real difficulties lie in collectives. He warned that if a collective scheme is not domiciled in the UK, it must still broadly comply with the same criteria as the UK version, otherwise it becomes a highly personalised bond.
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