This month our Short guide to series moves away from trusts and turns its attention to the taxation of investments. Margaret Jago outlines the issues relating to onshore bonds
Margaret Jago, technical manager, aegon Scottish Equitable International
Onshore bonds can be an attractive investment because of the simplicity of the taxation.
Onshore bonds invest in UK life funds that are subject to UK tax. Fund income not already taxed in the UK, such as interest or property income, is taxed in the fund at 20%, as are capital gains on fund assets. Dividends from UK companies are free of further tax, but will have been paid from the taxed profit of the paying company. So, overall, UK life funds grow net of tax.
One of the advantages of onshore life bonds is that the policyholder only has a potential UK tax liability if a chargeable event arises. Significantly, there is an annual allowance of 5% of premium that arises for the first 20 years and if withdrawals are taken within this allowance there is no chargeable event.
The allowance is cumulative, and can be carried forward until it has been used up by withdrawals from the bond in later years. This means that the policyholder may have no annual income tax liabilities, even if limited bond withdrawals are taken.
Policyholder tax liabilities arise if there is a chargeable event. Chargeable events are basically events where value is received by the policyholder other than through withdrawals within the 5% allowance mentioned above. So, when the bond pays out a death benefit or the investor cashes-in or sells their investment or takes withdrawals in excess of their 5% allowance, a chargeable event arises.
Where a chargeable event does arise there will only be a potential tax liability for the policyholder if the calculation laid down by the chargeable event rules produces a gain. If the chargeable event is a death, surrender or sale of the policy, the chargeable gain will be the actual growth over the life of the policy less any amounts of that growth that have already been taxed.
There is a pitfall to be aware of when the chargeable event arises because of withdrawals over the 5% allowance, however. The amount over the allowance will be treated as the gain, irrespective of the actual investment growth. Large withdrawals in the early years can give rise to disproportionate tax liabilities and, depending on the investor's tax position and on applicable product charges, the answer may be to cash-in some of the individual policies making up the bond.
Where a gain arises, the policyholder may have an additional tax liability. This is usually at their marginal tax rate, though all investors other than companies will have a notional tax credit at 20% for the tax paid within the fund.
Non taxpayers and basic rate taxpayers will have no additional personal liability on the gain itself unless the averaged gain pushes them into the higher rate band. Higher rate taxpayers will have a tax liability of 20% of the net amount of the gain, but this is calculated on the net return so that the effective overall rate of tax is a maximum of 36%.
If a bond is held in trust the settlor is taxed at their own marginal rate on trust gains. However, exceptions are where the settlor has died or is non-resident and where the trust is a bare trust, where the trustees are taxed and the beneficiaries are taxed respectively subject to the usual anti-avoidance rules that attribute income to the settlor if the trust is for their minor child.
Onshore bonds are generally very tax efficient and the lack of annual tax liabilities means they also simplify tax administration. Non taxpayers and companies are less likely to benefit from them fully due to the fact the fund taxation is not available for recovery or offset and they will be particularly suitable for basic rate taxpayers, higher rate taxpayers and for trusts.
Two global vehicles
'Further plug advice gap'
Must appoint separate CEOs and boards
Advisers do come out well
Will report to Mark Till