removal of 5% deferred tax rule on bonds could add up to billions for industry
Life and endowment business worth several billion pounds a year is to be stripped of key tax benefits under Ron Sandler's proposals to the Government.
In order to achieve a level tax playing field and simplify investment structures, Sandler has suggested the removal of the 5% deferred withdrawal rule on investment bonds. He has also asked for the abolition of qualifying life savings policies, which would affect endowment contracts. This has implications for the offshore bond market, which in 2000 brought in £5.65bn in new single premium business, according to the Association of International Life Offices.
According to ABI figures, £23m in new onshore unit linked and with-profits single premium individual life investment bonds were sold in 2001, down from the 2000 figure of £23.88m.
The 5% deferred tax rule is not a tax loophole but it is a feature, created in the 1970s, that has helped to underpin the popularity of single premium bonds. The rule in general affects higher rate taxpayers more than basic rate by allowing them to defer tax liabilities until the bond is cashed in. If, for example, clients invested £100,000 in an onshore bond paying an income of 5%, they are already paying 22% within the fund but higher rate tax payers do not have to pay the remaining 18% immediately.
When the bond is cashed in they would be liable for the remaining 18%, however, if they had retired by that time, their tax status may have changed to a basic rate tax payer. In this case, they would not be liable for any further amount.
In the case of an offshore bond, the underlying fund is not paying 22%. Tax is deferred but the investor still pays at his highest marginal rate, either 22% or 40% on encashment.
Gordon Richardson, trusts and tax manager at Hargreaves Lansdown, said the deferral has made the bonds attractive, especially within trust structures. The removal of the deferral would damage the popularity of the product, he admitted, although the bonds would remain suitable for many. Sandler's proposal that it should only apply to new business may create a buy-while-stocks-last scenario but his proposal is an improvement on the Government's when it tried to remove the 5% rule back in 1996, he added. Full removal would have cost billions in administration and reassessment costs.
Margaret Jago, tax specialist at Scottish Equitable, said Sandler's suggestion the removal be replaced with an economic reality of the withdrawal could be interpreted as investors being taxed on an element of the gain. Jago added the change would leave offshore bonds taxed in the same manner as offshore funds.
She said qualifying life savings policies allow regular premium contracts, such as mortgage endowments, with a life protection element to give rise to a tax free maturity. The removal of this, as Sandler has suggested, would mean investors would be taxed on the investment growth element in the endowment contract.
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