These will be particularly useful because:-
- They are non-income producing – there is no need to make an entry in the annual tax return until a chargeable event gain is made, say on full encashment or a withdrawal of more than the cumulative unused 5% allowances;
- No personal liability to basic rate tax arises on income and growth (although the income and gains generated by the investments underlying UK bonds are taxable in the hands of the insurance company);
- Tax efficient “income” can be taken in the form of partial encashments;
- The basic rules that apply to capital investment bonds with UK life companies mean that, when an investor encashes his bond, the gain will be added to his other taxable income and, if appropriate, (after top-slicing relief), he will suffer higher rate income tax. The gain under a UK bond is treated as having suffered basic rate tax and so the maximum rate of income tax that will arise on such a gain if an encashment is made in 2003/2004 will be 18%, i.e. 40% higher rate tax less 22% basic rate tax. Two particular points need to be noted here:-
- 1. the gain is not grossed up to reflect the basic rate tax paid within the insurance company's funds – it is the net gain that is chargeable; and
2. although the gain is treated as if basic rate tax has been paid, it is likely that the insurance company has in fact paid tax at a rate less than the basic rate. For example, insurance company policyholder funds would currently only suffer 20% corporation tax on savings income and dividends received with a 10% tax credit would bear no further tax. Moreover, although a life assurance company is liable to 22% corporation tax on capital gains, in practice this liability will be at a lower effective rate reflecting loss relief and the ability to only realise assets at the best "tax time". As indexation relief is still available to companies, this will apply to the insurance company's investments meaning that indirectly the policyholder benefits from this relief.
The upshot of all this is that although because of the basic rate credit a policyholder's gain will be treated as having suffered tax at 22%, it may in fact have only suffered tax at (say) 20%. This, combined with the fact that the chargeable event gain will not be grossed up for income tax purposes, will mean that the effective rate of tax on the gain may be as low as 34.4% for 2003/2004 notwithstanding that the policyholder is a 40% taxpayer. For this reason UK capital investment bonds continue to look very attractive for the higher rate taxpayer seeking capital growth in a tax-sheltered environment.
Of course, complete tax sheltering is available via an offshore bond but, on encashment, all gains will then be taxed as the taxpayer's top slice of income and be subject to tax at his marginal rate of income tax. Whether an offshore or UK bond is more appropriate in any particular case will depend on many factors including likely investment terms, returns, withholding taxes and charges.
It is also important to remember that neither taper relief nor the annual capital gains tax exemption can be used in respect of capital investment bond gains although, as mentioned above, capital gains made by a UK life fund will currently qualify for indexation relief which will have a downward impact on the effective rate of tax that the fund suffers.