Long live capital redemption bonds - an asset you cannot take to the grave
Bonds written on a capital redemption basis have received quite a lot of press following the Inland Revenue's decision to tax companies holding these investments on an ongoing basis, rather than when a chargeable event arises. While this has effectively removed most of the tax benefits for companies (although it should be remembered that for companies registered outside of the UK, capital redemption bonds may still be appropriate for tax planning) there still remains a large market for these products for both trustees and individual investors.
Before I discuss the tax planning benefits that a bond written on a capital redemption basis can provide, I will explain how they work.
For UK tax purposes, 'capital redemption business' means any business in so far as it:
• consists of the effecting on the basis of actuarial calculations, and the carrying out, of contracts of insurance under which, in return for one or more fixed payments, a sum or series of sums of a specified amount become payable at a future time or over a period; and
• is not life assurance business.
(Source: Section 458(3) Income and Corporation Taxes Act 1988).
In simple terms, this means a capital redemption bond is not a life assurance policy. It is a policy of assurance that will mature after a certain period of time (typically up to 99 years) with a minimum maturity value being calculated on an actuarial basis. In all other respects it is the same as a life assurance bond in so much that it is possible to surrender, or make withdrawals from the bond at any time before the maturity date.
Due to the guarantee of a maturity value, most jurisdictions require the life office to reserve a percentage of the initial premium for this event. In the UK this percentage is high enough for, as far as I am aware, no life office to offer capital redemption bonds. However, it is mainly those companies based in the Isle of Man who provide capital redemption bonds and are generally able do this for the same cost as a life assurance bond.
From a tax planning angle the key benefit of a bond written on a capital redemption basis is that death does not automatically trigger a chargeable event for income tax purposes which makes it a particularly suitable way of holding assets in trust for future generations.
This distinguishing feature has valuable advantages for the trustees. Under a last survivor single premium life assurance bond, death of the last surviving life assured would mean that the bond would end and the policy proceeds would become payable. This would constitute a chargeable event, which may give rise to a chargeable gain. The result may be an unexpected income tax charge payable by the settlor or trustees.
By choosing a capital redemption bond as an alternative investment, the problems associated with lives assured simply do not exist. The trustees can manage any tax liability by deciding when to exercise the following options:
• keep the bond in force;
• make further investments;
• take an 'income' in the form of regular withdrawals;
• change the investment funds selected;
• Surrender the bond;
• Assign the appropriate segments to the beneficiaries.
And of course these options are not curtailed by the death of the settlor(s).
From a practical point of view the setting up of a capital redemption bond is simplified due to the fact that there is no need to select any lives assured.
With such a flexible tax planning vehicle it would only be polite to pass it on, and on.
This article is based upon AXA Isle of Man Limited's current understanding of legislation in the UK and the Isle of Man.
According to Cicero report
Adds 24 staff, three offices and £275m AUA
Launches Junior ISA and retirement accounts
Schroders tops 2019 list
24 companies wound up