One bond better than another

The Chancellor’s proposed shake up of capital gains tax (CGT) in the recent Pre-Budget Report could be good news for offshore investment bonds at the expense of their onshore counterparts.

Ben Yearsley, investment manager at Hargreaves Lansdown, says the move: “Has practically killed onshore bond sales. Why would you go into them? Life funds are being taxed at the basic rate of 20%, with a further 20% to pay if you are a higher rate taxpayer. Whereas just buying investments outside of that wrapper will only levy an 18% charge.”

Matthew Woodbridge, bond manager at Chelsea Financial Services says that although buying a portfolio of unit trusts, rather than a bond, can therefore be seen as a plausible conclusion based on a CGT basis, investors and IFAs should not oversimplify the matter. However, he doesn’t necessarily believe that bonds would be killed off.

He says tax treatment of bonds is widely misunderstood and each investor should be treated on an individual case-by-case basis because this quite a technical area.

“They are quite a flexible product for basic rate tax payers. You get a relatively lower annual charge for expert fund management to do asset allocation for you, and the flexibility to take income in a fixed amount when you want it and how much.

“The key thing is to understand what rate of tax you will pay when you encash the bond such as when you are a lower rate tax payer or if you want to sign it to your spouse. They are a seemingly quite simple product on the surface but underneath the taxation is quite complicated,” he says.

Michael Greenwood, technical manager at Towry Law, doesn’t think life insurance investment bonds will lose their appeal if gains are taxed as income at the highest marginal rate rather than as capital gains subject to the new flat rate 18%. And he reiterates the point that the investors’ investment plans and needs should be met on an individual basis, whether they are basic or higher rate taxpayers.

“For higher rate taxpayers and trustees particularly, an offshore bond recommendation looks difficult to justify unless the structure is essential to inheritance tax planning or the bond is used purely for cash management or the benefits of tax deferral will prove real,” he says.

“It is essential to look ahead and consider the tax point when gains come into charge and the tax status of the chargeable person at that time. Collectives will usually produce a more tax efficient position and the margin makes any additional tax and trust administration worthwhile.”

The proposed changes may or may not go ahead in this present form, and investors and IFAs will differ in their reactions to them as regards investing in on and offshore bonds.

However, Yearsley concludes: “You have to reassess the rationale for being in investment (bonds) to make sure that they are still advantageous for you. Like it or not, in terms of tax simplification, it does make it a lot easier to deal with one flat rate of tax and to know what your position will be. You’ve got the annual limit and then the flat rate of 18%. It’s just much simpler. But I imagine it will get more complicated because they [the government] always change things again. As it stands now, it’s much simpler, and regarding investments that’s what you want to pay for.”

1 November 2007