Investments :  Taxation of Investment Bonds

Individuals will not normally have any personal liability to 22% income tax, nor to capital gains tax as these are met by the insurance company. Those paying basic rate tax and non-taxpayers cannot claim the tax paid within the fund. The only liability an individual can have is to higher rate income tax, and then only if their total income is high enough. This liability can arise:

• If you fully encash your bond
• If you withdraw more than your cumulative 5% annual allowances
• If you die
• If you sell your bond to someone else

It is possible for both basic and higher rate taxpayers to make withdrawals up to 5% p.a. (the annual allowance) based on the amount originally invested, free of any immediate tax liability. The 5% may be carried forward if unused, in part or in whole, to future years. At the time of encashment of the bond, these withdrawals will be added back to calculate the total encashment value. The 5% withdrawals may be taken for a total of 20 years (20 x 5% = 100%)

If in any year more than 5% is withdrawn, (including any entitlements from previous years) there may be a liability to income tax - at the difference between basic rate and higher rate - but only if you are a higher rate taxpayer at the time.

On death, the tax treatment is the same as if the Bond had been cashed in on the day before death, so the calculation of any additional tax is as in the above paragraph.

Those aged 65 or more should also bear in mind that there is the possibility of losing age allowance on encashment or on withdrawing more than the cumulative 5%. Age allowance is only affected if your income plus the amount cashed in (in excess of the accumulated 5% allowances) is more than £20,100 in the tax year 2006/2007.

The Budget in March 1998 introduced some changes to the taxation of chargeable gains on investments held in trust. If the settlor is alive and UK resident, then any tax liability falls on the settlor, based on their own circumstances. If the settlor has died or become non-resident, any tax liability falls on the trustees at the current rate of 34%. In certain circumstances this could mean that there could be an additional liability to 11% on chargeable events.

For trusts set up after March 22nd 2006 the rules have changed again and are a little more complicated. There may be an immediate tax charge on large investments and larger funds will suffer a tax charge every 10 years or on withdrawals. It is very important that you take advice when setting up new trust arrangements as if you are unaware of the pitfalls, you could unwittingly create a tax liability on the trust. Please contact us for advice on putting monies into trusts.

The Inland Revenue was carrying out an assessment of investment bond taxation and changes had been proposed. These plans have now been abandoned, and the current system is expected to remain in place.

Offshore Bonds

Apart from non-taxpayers, gains on an offshore bond are taxed at the bondholders appropriate tax rate, and the gain is added to their income in the year of encashment, in order to assess the rate of tax payable.