With stock markets volatile, cash funds are finding wider appeal. And by going offshore, there are tax benefits too.
Effective investment management is not just about picking the right investments, but also using their tax treatment to enhance returns. Changes to tax legislation effective from 6 April 2008 have provided compelling reason for UK resident and domiciled taxpayers to hold their cash in an offshore fund.
Why Cash?
Even before the recent stock market volatility and banking crises, there were good reasons to use cash funds both to meet short-term needs and for longer-term asset allocation.
An actively managed cash fund offers investors the opportunity to earn enhanced interest rates by pooling money, increasing buying power' and accessing wholesale money markets. A fund structure provides ease of dealing daily prices and quick settlement (currently transaction plus one day) compared to traditional higher rate deposit accounts which have lock-in penalties or long notice periods in return for higher rates.
A cash fund spreads money among a number of different institutions to diversify risk. Smith & Williamson offers a conservatively run cash fund. While other funds offer higher rates of return, this is often at the expense of transparency these funds could be investing in collateralised debt obligations, structured investment vehicles, commercial paper or derivatives.
Why Offshore?
To take advantage of the recent change in legislation, the Smith & Williamson Cash Trust has recently changed domicile from London to Dublin. The reason for holding a Dublin-based cash fund is the different tax treatment.
An individual investing in a Dublin cash fund pays tax on the dividend as if it were a normal company dividend, i.e. at 32.5% (higher rate) or 10% (lower rate). A similar dividend from a UK cash fund is taxed on the individual as if it were interest income, i.e. at 40% (higher rate), or 20% (basic rate). Therefore, there is an advantage for UK higher and basic rate taxpayers investing in a Dublin-regulated cash fund, even though they do not receive the 10% dividend tax credit.
With effect from 6 April 2008, subject to certain conditions, dividend income of UK resident and domiciled individuals sourced from overseas is now treated like UK dividend income and is eligible for the dividend tax credit of 10%. It should be noted that this treatment only applies if the individual owns less than 10% of the shares.
This means that the effective tax rate for a UK resident receiving dividend income from a Dublin cash fund is 25% (higher rate) and 0% (lower rate). This is substantially more attractive than the rate applied to income from a UK cash fund, which is still treated as interest income.
While stock markets remain volatile, retail deposit rates continue to fall and inflation creeps up, a combination of cash fund advantages and beneficial tax treatment offer nervous investors an ideal opportunity to stay in cash.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
