BLAGAB

Hi - you might want to revisit the course notes to check your understanding of the way in which tax is charged on I-E. I am not sure why you are applying 1/7 factors to the investment return component: it is only the BLAGAB acquisition expenses which are spread over 7 years in the tax calculation. This basically smoothes out the otherwise potential "lumpiness" of these (normally high) acquisition expenses.

 

Ah, I see. These 'deemed disposal' rules apply only to authorised unit trusts, UCITSs or OEICs. They do not apply to 'normal' internal unit-linked funds set up by insurance companies.

For unit trusts/UCITSs/OEICs, the liability to pay the tax amounts that are spread forward will be held as a deferred tax liability, so the price of each unit in the trust will be adjusted accordingly. This ensures that unitholders are charged equitably for the tax arising in respect of the investment returns from which they gain.

This is the same underlying principle as is described in Chapter 8 in relation to tax on unrealised gains on equities and properties: the unit prices are adjusted in relation to the tax liability which has accrued but which has not yet been paid.

Hope that helps.

 

Let's say that the fund is a unit trust. Then (simplistically) it would pay 1/7 of the tax arising in that year (thus reducing the value of assets held) and it would set up a deferred tax liability in respect of the remaining 6/7. So the net asset value (assets - liabilities) would be reduced by the full liability to tax on the I-C incurred that year.

Also during that year, it would pay the 1/7ths of tax carried forward from previous years, but it would also then reduce its tax liability in respect of those amounts - and these amounts should cancel themselves out.

Bear in mind that a deferred tax liability is a liability to pay out to HMRC in future. If there is a loss arising, then this could be treated as a deferred tax asset which could be offset against future tax. [You may be confusing tax assets and tax liabilities?]

So let's say that in Year 1 there is positive I-C and therefore 1/7 of the tax due is paid out to HMRC and a positive liability in respe t of the rest (6/7) of the tax is also set up. This in combination reduces the net asset value of the unit trust by the total tax incurred and hence similarly the unit price (based on net asset value per unit). So unit holders who are there in the first year have their unit values reduced to reflect the tax arising on the investment return that they have benefitted from, and the tax on that first year of investment return has been fully charged to those year 1 unit holders.

Unit holders who join in year 2 purchase units at this price, which has already had full account taken for the tax liability accrued (and partly paid) in the first year. So the only reason why these later unitholders would end up having to pay for any of the tax incurred in the past, before they joined, would be if the company mis-estimated the tax liability for some reason and there had to be a 'truing up' when the actual tax payments (of the 6/7 amounts carried forward) were made, relative to what had been set aside for them as a liability. This mis-estimation should be minimal, and could go either way.

Does that make things clearer?

 

If the company were to set up a deferred tax asset in respect of losses, it would have to assess carefully the extent to which it expected to be able to take some benefit from those losses in future. This is equivalent to the ideas that are discussed in Chapter 8 Section 2.3. In some cases, it may be decided not to take any credit for the carried forward losses (ie not set up a deferred tax asset) since, as you say, there might never be enough future gains against which to use them, particularly if the fund is in decline.

Sounds like you have got the hang of it now - well done!