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Pre-Budget tax changes to hit onshore and offshore bond market

The Chancellor’s pre-Budget changes to capital gains tax will damage the insurance bond market, tax experts warn.

The removal of both taper and indexation relief and introduction of a flat 18 per cent headline rate of CGT also raises a number of complicated advice issues.

Technical Connection director John Woolley says while some clients, particularly short-term investors, will benefit from the simplification, the changes mean that many people may be better off in an Oeic or unit trust.

He says: “The UK lump sum investment market via insurance bonds will be damaged by this. The playing field between life insurance funds and other collective investments is no longer level.”

Ernst & Young says the new flat rate of 18 per cent only applies to individuals and not to companies, so if shares are sold within a life fund they will be subject to tax at 20 per cent with indexation.

Taxbriefs director Danby Bloch says the new regime makes offshore bonds far less attractive for equity-based growth investments because capital gains are converted into income taxed at 40 per cent. This compares to 36 per cent of the gain effectively for onshore bonds because there is no grossing up of the gain to calculate the higher tax rate.

E&Y insurance tax partner Matthew Taylor says: “The last time there was a flat rate of capital gains tax in 1987 it applied to life company gains as well.  

“The relative positions of direct investment and investment through a life policy have shifted, and serious consideration will need to be given as to whether and how to rebalance them.”

Woolley says the issue of advising clients is further clouded now by the fact that investors holding income-generating funds within a life insurance bond will continue to benefit from being able to build up the dividend income without a further tax charge. Investors in unit trusts face a tax hit on their income stream, dependent on their earnings.

He says: “Advisers will have to be a lot more careful in understanding a client’s circumstances, particularly if the client is investing for income.”

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