Investment Bonds versus Unit Trusts or Open Ended Investment Account, (OEIC)

InvestmentsTaxation of:-

The UK Bond

Investment Bonds are taxed under the ‘chargeable event’ legislation, which means that chargeable gains are assessed to income tax rather than Capital Gains Tax, (CGT). The bonds suffer corporation tax inside the life fund. The actual rate paid within the fund will vary but the bondholder will be deemed to have paid tax in the fund at a rate equal to 20%, even when the actual rate is lower.

The Unit Trust or OEIC

UK Open Ended Investment Companies, (OEIC) and Unit Trusts receive all UK dividends and pay distributions without having to account for tax. Such dividends, (franked investment income) can be paid to investors with a notional 10% tax credit. All other forms of income, (unranked investment income) are subject to corporation tax at 20%. This could include interest, dividends from non-uk companies and rental income. They have an automatic exemption from tax on capital gains and pay corporation tax at 20% on taxable income.

The Bond holder

On encashment a higher rate taxpayer will pay an additional 20% on the net gain, which means the maximum effective rate will be 36% (20%/20%). From 2010/2011, an additional rate taxpayer* will pay an additional 30% on the net gain on encashment, which means the maximum effective rate will be 44% (20%/30%).

For basic rate taxpayers there is no further liability but there is no opportunity for starting rate or non-taxpayers to reclaim any tax paid or use any unused personal allowance.

The Unit Trust or OEIC Investor

Income tax is payable on interest and dividends arising from income and accumulation units. Income received is therefore taxed, even where re-invested, and is payable at the investor’s highest income rate. Dividend income is received with a non-reclaimable 10% tax credit.

For ‘additional higher rate’ tax payers dividend income is taxed at 42.5% so there is an extra 32.5% income tax to pay. Similarly, for ‘higher rate’ tax payers dividend income is taxed at 32.5% so there is an extra 22.5% income tax to pay. There is no further tax liability for basic or normal rate tax payers.

A flat rate of 18% CGT will apply to all realised gains on disposal of the investment. An annual exemption for individuals can be offset against any realised gains.

Advantages of the UK Bond

  • Bonds are non-income producing assets so there are no annual returns for individuals or trustees
  • Fund switching giving no rise to CGT or income tax liability on the investor
  • Switches in and out of funds are not subject to the CGT 30-day rule so will not give rise to a taxable event
  • Gains can have something called top slicing applied which could recue or remove any higher rate tax liability
  • Bonds can be assigned gifted away without giving rise to a tax charge, although Inheritance Tax, (IHT) may apply
  • A tax deferred allowance equal to 5% of the original investment can be taken each year without creating an immediate tax liability. If not taken in any one year they can be rolled up for future years
  • For the purpose of Age Allowance, withdrawals of up to 5% tax deferred allowance are not treated as income
  • Bonds can be set up in joint names at the outset to avoid a chargeable event on the first death
  • Single premium investment bonds are not normally included where means tested is applied by local authorities for residential care

Advantages of the Unit Trust or OEIC

  • Capital Gains Tax, (CGT) rate of 18 per cent and 28 per cent for individuals (the rate used will depend on the amount of their total taxable income and gains), 28 per cent for trustees or personal representatives, 10 per cent for gains qualifying for Entrepreneurs’ Relief.
  • The Annual Exemption of £10,600, (£5,300 for Trustees) can be used to offset CGT, (2011/2012 tax year).
  • Unused losses can be carried forward to offset against future gains
  • Clear pricing
  • Suitable for trust investments where beneficiaries are entitled to capital or income
  • Switched within the fund will not give rise to CGT
  • Gains realised whist non resident may not be liable to UK tax, (subject to the duration of the non-residency)
  • The first £10,680 can be placed into a Stocks and Shares Individual Savings Account, (ISA)

* 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 initial consultation is covered byTemplegate.

So what next? The only thing left for you to do is pick up the phone and call Templegate on 01264 300125,0845 833 8837 or, email info@templegatefinancial.co.uk or, complete our enquiry form.

Templegate Financial Planning Ltd is an appointed representative of Sage Financial Services Ltd, which is authorised and regulated by the Financial Services Authority. Sage Financial Services is entered on the FSA register (www.fsa.gov.uk/register) under reference 150452. The FSA do not regulate will writing services or some forms of mortgages and inheritance tax planning. The information and content of this website is intended for UK consumers only and is subject to the UK regulatory regime. Templegate Financial Planning Ltd. Registered Office: Winton House, Winton Square, Basingstoke, Hampshire, RG21 8EN Registered in England No. 04416499.