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Tony Wickenden: Reviewing portfolios post-CGT and dividend tax changes

Tony Wickenden

As I mentioned last week, two of the key Budget changes should be considered fundamentally important for investors and their advisers.

These are the introduction of the Lifetime Isa and the reduction in the rates of capital gains tax. This week I am going to spend some time looking at the latter. This change, along with the changes to dividend taxation, combine to cause investors and their advisers to seriously reconsider investment decision- making. The resulting conclusions reached may not necessarily be different from what they would be before these changes take effect but this does not diminish the importance of reconsideration.

Given the reduction in CGT rates – from 28 to 20 per cent and from 18 to 10 per cent – some have suggested reconsideration should be given to the growth or income decision.

The new CGT rates are half the rates that apply to taxable income for basic rate and higher rate taxpayers – even lower for additional rate taxpayers. There is also the fact the first £11,100 of capital gains realised in a year are exempt. On the income front, apart from the personal allowance – likely to be used up by other income such as earnings or pension – there is the £5,000 dividend tax allowance and the £1,000 (basic rate taxpayer) or £500 (higher rate taxpayer) personal savings allowance for interest.

For most investors the relative importance of these tax fundamentals will be a consequence of the portfolio selected as opposed to driving the suitability of the portfolio for a particular investor. In other words, tax should not be the main driver of portfolio construction, even when gains are taxed at half the rate applicable to taxable income. This conclusion is strengthened by the fact, for many, the £5,000 dividend tax allowance will mean the yield from their portfolio is either tax-free or taxed at a lower overall rate than it is currently.

When considering the tax characteristics of a portfolio you have to consider the taxation of both income and capital. For most investors there is an improvement in both in relation to unwrapped investments such as direct investment into collectives. So basing a portfolio decision on the reduction in CGT rates or the dividend tax allowance alone would probably result in an unbalanced conclusion.

It may be the question to consider is not so much growth or income but whether the portfolio you choose should be wrapped in a UK or offshore investment bond to deliver the optimum tax outcome for the investor.

In relation to capital growth, the CGT annual exemption and a rate of 10 or 20 per cent outside the bond will make it hard to argue a case for the tax deferment qualities of an onshore bond – unless the investor has used their annual exemption, is a higher rate taxpayer and the life company concerned reserves for tax on realised, or deemed realised capital gains, a rate substantially lower than 20 per cent.

Of course, offshore bonds have no tax liability at life fund level on realised or unrealised gains so if capital gains are expected to be significant and the deferment period is likely to be long, then the offshore bond may offer some attraction, although not as powerfully as it would have before the CGT rates reduction we will benefit from in 2016/17.

As a rule of thumb, when the dividends would fall within the tax-free dividend allowance there can be no income tax benefit in holding the equities producing the dividends inside a bond.

Above that level, the tax rates have increased by 7.5 per cent so the tax-deferment qualities of a UK or offshore bond might then start to look attractive. Do not forget there is no tax at UK life fund level on dividends but there is a basic rate credit. There is no such credit for gains realised on encashing an offshore bond. For multi-asset funds it is worth remembering unless the underlying investments are more than 60 per cent in basically fixed interest, the income paid from the fund will be eligible for the £5,000 dividend allowance.

As ever, the longer the investment period and the greater the dividend the more powerful the tax deferment case for a bond. Provided you can access the investments you want, a UK bond would seem to be preferable for individual investors.

So much to consider then. It is not – and never was –cut and dried. But if you want a rule of thumb, in a balanced portfolio, the tax case for an investment bond may be hard to make unless the dividends exceed £5,000 a year and capital gains exceed the annual exempt amount.

Tony Wickenden is joint managing director of Technical Connection. You can find him tweeting @tecconn



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  1. ….or the client has an eye on future assessability for LTC fees?

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