UK open-ended investment companies (OEICs) and unit trusts receive UK dividends and pay dividend distributions without having to account for corporation tax. However, such dividends (franked investment income) will be paid to investors with a notional 10% tax credit.

All other forms of income (unfranked investment income) are subject to corporation tax at 20%. This could include interest, dividends from non-UK companies and rental income.

Collective investments have an automatic exemption from tax on capital gains and pay corporation tax at 20% on taxable income (less management expenses and interest payable). Finance Act 2009 has provided greater certainty regarding which activities carried out by a collective would be classed as ‘trading’ and hence subject to corporation tax, with effect from September 2009.

Income tax is payable on interest and dividends arising from income and accumulation units. Income received is therefore taxed, even where reinvested, and is payable at the investor’s highest income tax rate.

Dividend income is received with a non-reclaimable 10% tax credit. For higher rate taxpayers (HRTs) dividend income is taxed at 32.5% so there is an additional 22.5% income tax to pay in 2009/10 and 2010/11. This is equal to 25% of the net dividend received. For additional rate taxpayers* there is an additional 32.5% from 2010/2011. This is equal to 36.1% of the net dividend received. There is no further income tax liability for basic rate and non-taxpayers. For certain trusts, dividend income is also taxed at 42.5% so there is an additional 32.5% income tax to pay from 2010/11, again equal to 36.1% of the net dividend received**.

Where unfranked investment income is paid net of 20% corporation tax, there is a further liability of 20% of the gross gain for HRTs, 30% for additional rate taxpayers and trustees. There is no further liability for basic rate taxpayers and non-taxpayers can reclaim the 20%.

A rate of 18% or 28% (or a mixture of both where the chargeable gain, when added to the individuals other taxable income straddles the higher rate tax threshold) after any available annual exemption has been applied (£10,100 for 2010/11). Unused investment losses can be carried forward indefinitely to offset against future gains, provided the losses have been registered with HMRC.

• Capital gains tax (CGT) rate of  18% or 28% for all taxpayers depending on their other taxable income.
• Base cost of investment for CGT purposes is revalued on death.
• Able to use personal or trustee CGT annual exempt amount to reduce gains.
• Unused losses can be carried forward indefinitely (provided that they are registered).
• Transparency of pricing.
• Can be real income-producing or growth-orientated investments.
• Can be suitable for trust investments where different beneficiaries are entitled to income or capital.
• Up to the first £1,000 of discretionary trust income in a tax year is charged at 10% or 20% depending on the nature of the trust income.
• Can utilise minor’s income tax and CGT allowances (income tax allowance use may be restricted to £100 in any tax year under the parental settlement rules).
• Excluded property for IHT purposes for non-UK domiciled investors.
• Fund of funds – switches within such funds will not give rise to a personal CGT liability.
• Gains realised while non-resident may not be liable to UK tax (subject to duration of non-residency).
• Trustee rate of 28% is still lower than rate applicable to trusts.

• Fund switches can give rise to a personal CGT liability.
• Change of ownership may give rise to a CGT event (other than transfer to spouse) including to a trust.
• Bed and Breakfast rules apply on switching in and out of the same funds within 30 days.
• Collectives are normally included where means testing is applied by a local authority for residential care.
• Income producing asset so possibility of annual tax returns for individuals or trustees.
• HMRC self assessment reporting of disposals is required even where no gain is realised or the gain is less than the annual exempt amount (if proceeds exceed £40,400 for 2010/11 tax year).
• All income received is liable to tax up to 50% from 2010/11 as it arises, on both income and accumulation units.
• Dividend income distributed to beneficiaries from a discretionary trust is taxed as trust income, ie at the special trust rate of 50% from April 2010/11.
• The 10% tax credit cannot be reclaimed from dividend distribution.
• Complex part disposal calculations, for regular withdrawals.

This article should be read in conjunction with 'Taxation of collectives when held directly'.

* Finance Act 2009 introduced a top rate of income tax of 50% for trusts and for individuals (referred to in this document as ‘additional rate taxpayers’ )with income in excess of £150,000 from April 2010.
** The first £1,000 of trust income each tax year is charged at 10% or 20% depending on the nature of the income. Finance Act 2009 increased the rate of tax from 32.5% to 42.5% from 2010/2011.