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Home Guide to investment companies What are investment companies? |
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Split capital structuresSplits are companies with a portfolio of investments just like all investment companies, but they issue two or more different types of share. The different types of shares in the company are designed to meet different investors' needs. This page will tell you about
What are splitsSplits were first introduced in 1965. The original split capital trust structure had a limited life with a fixed wind-up date and issued two classes of share namely, income shares and capital shares. Income shareholders were entitled to all the income generated from the investments held by the company during its life, whilst capital shareholders received, at wind-up, the capital value of the company, including any capital growth achieved by the company over its life. This enabled investors to concentrate on either capital growth or income exclusively and receive a potentially greater level of return from the larger pooled amount. This is a form of gearing known as structural gearing, and is explained further down this page. Over time, a much wider range of split structures and share types has developed, catering for a variety of investor needs in terms of both risk and return. Each type of share within a split company structure has a predetermined order of entitlement during the life of the company and at wind-up. Although there is an order of priority, investors should be aware of the rights and entitlements of any prior charges, such as bank loans and all share classes within the split structure. Splits, like all other investment companies, vary in overall investment policy, objective and strategy; therefore each split will be exposed to different potential returns and risk. This in turn affects the potential return and risk characteristics of the share classes within each structure. The advantages of splits are that they can provide for a range of investment needs, and if you want to invest for a fixed period, they can give you a specific date for a potential capital payment. In addition, some share classes have no income associated with them, so there's no income tax to pay. Splits can be complex investment vehicles and investors need to ensure they fully understand the split capital structure before investing. If investors have any doubts about whether splits are appropriate for them, or require further information, they should seek professional financial advice before investing. Limited LifeAn important concept to understand is limited life. At least one class of share in a split is likely to have a limited life. This means that at a specified date the company will need to realise a specified value from the underlying investments to distribute to the share holders of the limited life share. If the whole company has a limited life this triggers the termination of the company or the wind-up procedure. This includes realising its assets, paying off prior charges, such as bank loans (if any) and other creditors, and distributing the remaining assets among shareholders according to the correct order of priority and the various share class entitlements. Limited life is also important in that the length of life of the company affects the ability of the company to generate growth both in terms of income and capital. What happens at wind-up?At a predetermined date, shareholders with voting rights are asked to agree to wind-up the company according to the procedure laid down in its constitution, thereby enabling them to receive the predetermined entitlement of their investment, provided sufficient assets are available. They may, however, be given the option of continuing the life of the company, by rolling their investment over into a new or existing vehicle or taking a cash exit. If the investment is rolled over, this may have important tax implications for an investor as this will normally be structured in such a way as to avoid any charge to Capital Gains Tax. If the investment is realised in cash, then a capital gain may arise on which you may have to pay Capital Gains Tax depending on your personal tax position. If the company winds-up, the shareholders are repaid in order of priority out of the assets available after any prior charges and expenses have been deducted. Although some split shares have a limited life, the shareholders are not obliged to hold their shares until the final wind-up date. They can be sold on the secondary market at the prevailing market price during the life of the company. Share Classes, investor needs and order of priorityEach split is unique and it is important to be aware of the rights and entitlements of any prior charges and of each of the share classes within the split structure. Share class risk exposure will vary between each split. The information that follows below provides details on the different classes of shares that may exist in a split structure, information about the shares order of priority and entitlement, as well as some information about the tax implications of investing in the different share classes. Each class of share in a split follows a particular order of entitlement to capital and right to income earned by the company during its life, and at wind-up to capital paid from the assets of the company. If the company has prior charges such as bank loans or loan stock, these rank ahead of equity shareholders. In other words, for every split, there is a set sequence in which the various classes of share returns are paid. For shares where the income entitlement and/or redemption value is predetermined, this is not a guaranteed return and depends on the assets and revenue available within the company. Depending on the underlying investment portfolio and the complexity of the structure, the further down the chain of entitlement the greater the effect on the potential return and risk of each share class. Zero dividend preference sharesZero dividend preference shares ("zeros") have a limited life. They are set up with the aim of delivering a pre-determined capital return to investors when the wind-up date is reached. This is called the redemption value. A zero's rate of growth is pre-determined by the company at launch. This means that even if the company performs better than expected, zero holders will only receive the predetermined redemption value set at launch date. Although the redemption value may be pre-determined, this is not a guaranteed return - if the company performs poorly, the company may not be able to pay out the pre-determined amount. Zeros are preference shares and, as such, are usually (but not invariably) the first shareholders to be entitled to capital of the company at wind-up, after the company has paid any prior charges including any bank debt. "Zero dividend" means that zeros don't provide income, so there's no income tax to pay. They have no entitlement to income and are therefore not subject to income tax. Any profit on the sale or redemption of a zero is taxable as a capital gain. This makes them tax efficient for people who pay income tax but who do not make full use of their annual Capital Gains Tax allowance. Income sharesIncome shares aim to provide shareholders with regular returns in the form of share dividends. These dividends are generated from the company's underlying investments, paid in the form of dividends. The range of income entitlements of income share classes includes;
Some income shares may also have entitlements to some of the company's capital on wind-up. Any capital entitlement is usually pre-determined by the company - in other words, it won't be more than a fixed amount. There is no guarantee that you will receive the pre-determined amount if the company performs poorly. Both the income and capital entitlements vary between each split structure. Some very high yielding income share classes pay back only a fraction of the issue price at windup. These are referred to as annuity income shares, which are typically entitled to all the income from a company's portfolio, but only to a nominal capital repayment value at redemption. Annuity income shares aim to offer a high yield at the expense of capital. The term 'annuity' is colloquial in this context and should not be confused with life assurance annuities. Income share entitlements to income depend on the structure of the company. Distributable income will depend on the entitlements of any prior ranking charges. Any predetermined capital entitlement ranks after payment of any prior ranking charges - these could include the company's outstanding debt and/ or payment of higher-ranking share classes, like zeros. The dividends on income shares will be taxed like any other UK dividend and are therefore subject to income tax. As the characteristic of an "annuity" income share is that its issue price is far higher than its redemption price, it is likely that a capital loss will arise. Whether this is an allowable loss for tax purposes is uncertain and professional advice should be taken. Ordinary income sharesOrdinary income shares offer a combination of potential high and rising income and potential capital growth at a higher risk relative to other classes of share. Depending on the structure of the company in which the ordinary income share is issued their entitlement to income may vary from:
They have no predetermined capital value but are entitled to all surplus assets on wind-up of the company after prior ranking charges. Distributable income will depend on the entitlements of any prior ranking charges. The shares usually rank last in the company's repayment order of capital and are therefore geared by the existence of prior ranking shares and charges. This means if the company does well, ordinary income shareholders are likely to do very well indeed, but if it does badly, they fare very badly. By implication they are higher risk. The dividends on such shares will be taxed like any other UK dividend and are therefore subject to income tax. Any gains or losses made on the sale or redemption of the shares will be taxable as a capital gain/loss. Capital sharesCapital shares offer potential for above average capital growth at higher risk relative to other classes of share. Capital shares have no predetermined capital value but are entitled to all of the surplus assets on wind-up of the company after prior ranking charges. They are geared by the existence of prior ranking charges and if the capital value of the underlying assets of the company performs poorly, or does not perform at all, these shares will suffer a severe decline in asset value, possibly providing no return at all. The shares rank last in the company’s repayment order for capital. Any gains or losses made on the sale or redemption of the shares will be taxable as a capital gain/loss. Capital shares receive no income, so therefore returns are not subject to income tax. Unit sharesSome splits arrange for a combination of their share classes to be traded together in what is known as a "unit". This combination will vary depending on the company. Units which are structured in the same ratio as the component share classes of the company may be considered and analysed as the reconstituted ordinary share of a conventional company. Structural GearingSplits may be financially geared but they will also provide gearing to their share types through their capital structure, this is called structural gearing. This type of gearing is created due to the predetermined entitlement and order of priority of the share types within the structure. The returns to each class of share are governed by the effects of the entitlements of the other share classes. The number of share classes and the proportionate entitlement of each determine the level of gearing involved. Shares in splits with high levels of financial gearing in addition to their structural gearing will be exposed to higher risk. Shares further down the order of entitlement are subject to greater gearing and higher risk within the structure. | |
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