threat of £1bn tax bill recedes with victory in test cases brought by Lloyds TSB and Nationwide
Life companies have won their battle with the Inland Revenue over the retrospective tax liabilities of high yield and guaranteed growth bonds.
Victory in the two test cases, pending any appeal, means the threat of an estimated industry-wide tax bill of up to £1bn on such products has receded.
As previously reported in Investment Week, the life divisions of Lloyds TSB and Nationwide had brought test cases to the special commission, an independent body appointed by the Lord Chancellor's office which adjudicates on disputed tax cases, over the Inland Revenue's proposed changes to the taxation of derivative-backed products.
In both cases, the commission ruled against the Revenue's interpretation of the guidelines surrounding the taxation of guaranteed products.
The Revenue had sought to tax returns from such products as income rather than capital gains, as had previously been assumed. Income tax is a higher rate of tax than capital gains when applied to this kind of product. Although providers had conceded the Revenue was entitled to change its interpretation of how such products should be taxed, they argued that any such change should only apply to new issues and not those that are already under way.
One company affected by the outcome of the cases, Eurolife, had gone so far as to withhold money from investors in its high income bond, which had matured in May, pending an outcome. The company held back 4.75% of investors' original capital in order to pay any increased tax bill, although it had returned all of the bond's upside. Had the decision gone against Eurolife, a further six bond issues maturing between now and 2005 would have been affected.
Eurolife managing director, David Wootton, said: 'We're delighted to hear of this result. The decision of the special commission justifies our stance on this matter. We will of course be returning all of the withheld money as soon as possible, although this will not be until after any appeal.'
Wootton said he expected the Government would issue new legislation clarifying the tax position of derivatives in the near future. However, he pointed out that Eurolife was no longer producing products that used life assurance contracts as a tax wrapper in this manner.
Going forward, all new offerings would take the form of Dublin-based companies, he said, as the format was more tax efficient. He added that this decision had been taken some two years ago and was not a result of the confusion surrounding the taxation of onshore high income bonds.
'If a UK resident invests in shares of a Dublin-based company, then they have two options,' Wootton said. 'Dividend income is taxed at 10% while only growth option returns exceeding the CGT tax allowance will be taxed. Using a life wrapper currently means all returns are taxed at 20% plus, and possibly more following any new legislation.'
Mark Jenkins, managing director at Nationwide Life, said: 'We are obviously very pleased with the judgement of the special commission which fully supports our view on the taxation of these products. Guaranteed equity bonds have been a popular product, offering the opportunity for stock market growth along with guaranteed capital protection.'
A spokesman for the Inland Revenue said it was considering the result and would comment in due course.
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