Cut your tax bill with B shares

Investors wanting to minimise higher-rate tax liabilities, and still receive attractive distributions from investment trusts, should consider the new breed of B shares.

Pioneered in 2007 by Investors Capital Trust, the concept has been taken up by Perpetual Income & Growth Investment Trust.

If the latter's proposed issue proves popular it could be emulated by other large trusts in the UK growth and income sector.

What is a B share?

The B shares are almost identical to a trust's ordinary or A shares: they share the same portfolio, have the same net asset value (NAV) per share, and receive payouts at the same time as, and in an equal amount to, each net dividend paid.

Their attraction is that the payout comes as a capital distribution instead of a dividend.

As a result, whereas dividends on A or ordinary shares may be liable to higher-rate tax if they are not sheltered in an individual savings account or pension, capital distributions on B shares are treated as 'small capital receipts' for tax purposes, so are free from immediate tax and may not need to be included in tax returns.

So what's the catch?

The catch is when the investor sells B shares: an amount equal to the total distributions received must be deducted from their base cost, increasing potential capital gains tax (CGT) liability.

But this may be covered by the holder’s annual allowance, and there is no CGT if shares are held until death.

Also, CGT, at the flat rate of 18%, is less than the potential higher-rate tax on dividends.

The mechanics of the new breed of B shares are outlined in the profile of Investors Capital Trust managed by F&C.

But there is a potential drawback: capital distributions are funded from the combined assets of the two classes so act as a brake on the growth in the mutual NAV per share.

The quid pro quo for the A or ordinary shares is yield enhancement: it is bolstered by income earned on the funds contributed by the B shares.

Dividends on Perpetual Income and Growth Investment Trust's ordinary shares are expected to rise by at least 10% following its B share issue, which could  help to lower its discount to NAV.

David Barron, who heads JPMorgan's investment trust business, says B shares seem a sensible option for those wanting returns in capital form, but warns that trusts following Perpetual Income and Growth Investment Trust's example must be large enough to ensure liquidity in both share classes, which indicates minimum assets of £400 million or so.

Spotlight on Investors Capital Trust

Investors Capital has been managed by F&C's Rodger McNair since 1999, but it has changed since its new structure was adopted in 2007, with capital divided into A and B shares in the proportion of three to one.

Shareholders' funds are mostly invested in a concentrated portfolio of large and mid-sized UK equities.

Its 32% gearing is invested mainly in corporate bonds, which yield more than enough to cover the borrowing costs. But the equity/bond ratio is adjusted to take account of investment prospects.

The assets of A and B shares are combined into one portfolio, with all income allocated to A shares. This boosts their potential distribution by 33%, so dividends for the year to 31 March will total 5.35p, giving a yield of 6.7%.

In return, the B shares will receive capital distributions totalling 5.35p paid out of the trust's combined assets.

This reduces the mutual NAV per share, but as only a quarter of the capital is in B shares the reduction is equal to a quarter of the dividend distribution or 1.34p for the year to March 2010.

McNair says bolstering the revenue of A shares with the income foregone by B shares enhances his flexibility by lowering the yield requirement.

This may bolster capital growth by more than enough to compensate for the capital used to pay the distributions on the B shares.

"At the time of the reorganisation we consulted shareholders and decided a bit more of a capital hurdle in return for more flexibility in the investment profile was worthwhile," he says.
As proof that Investors Capital B shares are popular, they trade at a premium. The A shares are at a discount.

This article was originally published in Money Observer - Moneywise's sister publication - in May 2010

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I qualify for maximum age allowance,so am interested to know whether the amount alllowed before Tax for us has/will be increased by £1,000 as it has been for the younger generation?