Now that commission can no longer be paid on advised sales of offshore bonds in the UK, more and more of us are becoming used to the idea of adviser charging.
This also applies in other countries including Australia, India and the Netherlands; how long will it be before the same concept spreads within the EU and further afield? Crown dependencies such as the Channel Islands and the Isle of Man are expected to bring in their own Retail Distribution Review legislation in 2014, but this will not necessarily mean a ban on commission fees.
In many cases for UK advisers, not only will there be an initial adviser charge at the outset but there will also be ongoing adviser charges throughout the lifetime of the contract. How do the new rules work in practice and what options are available to facilitate the collection of these charges?
Initial charges
Addressing initial charges first, the rules allow these to be expressed either as a monetary amount or, if preferred, they can be expressed as a percentage of the amount to be invested. Perhaps the simplest way to collect the initial charge is for the client to pay it direct to the adviser, sending a separate remittance to the product provider to be invested in the bond. This approach will certainly provide clarity of which amount is paying for what. But is there a more convenient method?
Two payment methods
The rules allow for the initial adviser charge to be paid by the product provider in one of two ways. Whichever of the two methods is chosen, this might be regarded as more expedient for the client, since only one remittance has to be sent to the product provider.
The first method is known as provider-facilitated. Using this, the client pays the whole amount, both the amount to be invested and the amount of the initial adviser charge, to the product provider. Before transferring it into the bond wrapper, the product provider separates the amount of the initial charge agreed between the client and the adviser, then pays this direct to the adviser. The net amount is then invested in the bond and it will be this net amount upon which all future tax-deferred 5% cumulative allowances will be based.
The alternative method is referred to as product-facilitated. Here, as before, the client pays the total amount to the product provider as one remittance. The difference, however, is that the product provider invests the whole amount in the bond. Immediately the bond is in force, a withdrawal is taken from it and is paid directly to the adviser.
Compared with the provider-facilitated method, this approach does result in a higher amount upon which future tax-deferred 5% cumulative allowances will be based. However, it also means that part of the bond’s first year’s allowance is used up, as payment of the initial adviser charge will be regarded as a partial withdrawal.
Ongoing charges
Once the offshore bond is in force, consideration needs to be given to any ongoing charges that have been agreed between adviser and client. As with the initial adviser charge, the rules allow the ongoing charges to be expressed either as a monetary amount or as a percentage of the amount originally invested. Here, however, there is a third choice; if preferred, the adviser and client can agree that the ongoing charges be based on a percentage of the current fund value. Clearly, this will mean that the amount will vary at each payment, since the fund value will be a different value at each payment date.
Although it is perfectly acceptable for the client to pay the ongoing adviser charges as a separate remittance to the adviser each time they arise, this may be regarded as somewhat of an inconvenience. Indeed, this would be most impractical where it had been agreed to base the charges on a percentage of the current fund value. Fortunately, the new rules do allow ongoing adviser charges to be generated by withdrawals from the offshore bond itself.
While the adviser and client can agree on the frequency of payment for the ongoing charges, it should be recognised that, where an offshore bond has been taken out, some funds will be valued only once a quarter. Therefore, in these circumstances, if the ongoing adviser charges are to be based on a percentage of the current fund value, they cannot be paid more frequently than once a quarter. If they were to be collected monthly, for example, two out of every three payments would be based on out-of-date valuations.
Tax allowance
If regular withdrawals are taken from the bond to pay for the ongoing adviser charges, it should be recognised that, as with the product-facilitated method of collecting the initial adviser charge, these withdrawals will use up all or part of the cumulative 5% tax-deferred allowance. Indeed, if the client is also taking partial withdrawals in addition to the withdrawals to pay the ongoing adviser charges, the total withdrawn might inadvertently exceed the available cumulative allowance. If so, an unintentional chargeable event gain could be triggered, resulting in a potential income tax liability being assessed on the client.
This is a real danger where the ongoing adviser charges are to be based on a percentage of the current fund value. The charges based on this method will vary in amount each time. On the other hand, the 5% tax-deferred allowance will be the same each year, since it will be based on the amount invested at outset. This means that, particularly if the client is taking regular partial withdrawals, the adviser will need to monitor the fund value continuously if chargeable event gains are to be avoided.
Fortunately, some product providers are able to offer the facility to incorporate a maximum amount on the withdrawals used to pay
ongoing adviser charges. This will help to prevent inadvertent chargeable event gains without the need for constant monitoring of the level of withdrawals.
Exchange rates
Another consideration for UK-based adviser firms is currency. Where a bond is set up in any other currency than sterling, each time an adviser charge is taken there is the exchange rate to be taken into account.
This is all well and good where the bond is being taken out simply as an offshore investment. But what is the position where the bond is part of some kind of trust arrangement? Here, we need to think about who is receiving the advice and, therefore, who should pay for it.
Generally, the initial advice will be given to the client. It is therefore the client who should pay the initial adviser charge. However, it would be inappropriate for this charge to be paid by using the product-facilitated method. Most trusts will exclude the settlor (the client) from benefiting, so it would not be possible for a withdrawal from the bond to be used to pay a charge that the client had agreed to pay. Even if it were possible, the ability to do so would undoubtedly be regarded as a reservation of benefit, thus rendering the trust ineffective for the purposes of inheritance tax.
Where the offshore bond is to be issued subject to a trust, therefore, the initial adviser charge should be paid by the client as a separate
remittance direct to the adviser or by using the provider-facilitated method described above.
Ongoing charges
What about ongoing adviser charges? For an offshore bond under trust, ongoing advice will be given to the trustees, so it will be the trustees’ responsibility to pay the ongoing adviser charges. In many cases, the only asset within the trust will be the offshore bond, so these charges will need to be generated by taking partial withdrawals from the bond. As described above, care will need to be taken to ensure that the 5% tax-deferred withdrawal allowance is not nadvertently exceeded, either by constant monitoring or by taking advantage of the product provider’s facility, if offered, of imposing a maximum amount on the ongoing adviser charge.
Trusts
Finally, we need to return to the initial adviser charge where the bond is to be made subject to a trust. In certain circumstances, the trust will be set up by the client transferring a cash sum to the trustees, either by way of gift or loan (or both), and the trustees subsequently using the cash to take out an offshore bond. Who is receiving the initial advice in these circumstances?
It seems clear that the initial advice in relation to setting up the trust has to be given to the client, so the client will pay for that element of advice. Since the trust itself will not be regarded as a financial product, VAT will need to be charged on this amount if the adviser is VAT-registered.
There will also be initial advice given to the trustees. However, this is clearly given with the intention to provide an exempt financial product – the investment bond – which means that the initial adviser charge that the trustees are responsible for will be exempt from VAT.
While it will be seen that the new rules on adviser charges provide elements of choice and flexibility, not every product provider is able to facilitate all of the features described above. It is therefore important that you discover which provider offers what facility before agreeing with your client how initial and ongoing adviser charges are to be collected.
