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Bonds and OEICs – tax matters

OEIC Funds – internally

Internal OEIC Funds

An OEIC that is treated for tax purposes is a subject to Corporation tax , which is similar to investment companies.

Instead of Corporation Tax that does not apply, special tax applies which is equal to lower rate of Income Tax the rate of which is 20% currently . No tax is owed on capital gains as they are not subject to Corporation Tax.

Alternatively, on disposal of shares, the investors are possibly responsible for Capital Gain Tax (CGT). There is no Corporation Tax chargeable on UK or overseas dividends that are earned.

One can claim for Tax relief on expenses that are done on management activities.

OEIC Funds – externally

If the “qualifying investments: test is met by a particular OEIC fund then either dividends or interests are paid. If the market rate of qualifying investments surpasses 60% of all investments, the test is believed to be satisfied. Qualifying investments give returns if their economic substances are similar, whether they yield interest or not. Largely, thus, a corporate bond fund would pay interest and an equity fund would pay dividends .

Individuals get interests from an OEIC net of 20% tax deducted at source, which is further paid to HMRC. Dividends which are earned are handled in the same way as any other company dividend in UK carrying a one ninth non-repayable tax credit that will meet any income tax responsibility in the beginning or basic rates.

Earnings will not be dispersed instead invested again (net of any tax deducted) and added to capital if an investor holds units to accumulate. However, the distribution continues to remain as earnings to meet Income Tax purposes. To save on double taxes, the estimated dispersal is seen as allowable expenses for Capital Gain Tax purposes on following disposal.

Personal Investments

Know the tax implications of an Open Ended Investment Company (OEIC) and/or insurance bond investment. One has to consider both internal tax and external tax.

  • OEICs and bonds are just opposite to each other on the income spectrum
  • One has to consider both “internal” fund tax and “external” personal tax.
  • OEICs has to disperse existing earning; bonds are investments that do not produce income

The general CGT rules for share will be applied, as administration of shares may generate a CGT responsibility. Shareholders can interchange shares in one sub-fund for shares in another if it is case of a company with a number of sub-funds under one umbrella. It is a disposal of Capital Gain Tax purposes, if an individual move out of one continuing sub-fund into another.

UK bonds – internally

The funds essential to the UK bonds policy are bound by UK life fund taxation. The earnings and interest earned from it are taxed at 20% and dividends are relieved, which is similar to an OEIC fund. However 20% tax is charged on Capital Gains after regulation of allowance that removes the tendency of inflations from the gains. Hence, in real the rate that is affected will always be lesser than this in spite of the fund being seen as having paid tax at basic rates.

External UK bonds

UK Bonds are liable to the “chargeable event” system while personal tax is paid only when profit is considered on an event that is chargeable. Following are the main chargeable events:

  • Rise of benefits from deaths
  • All rights assignment under the policy for money or money's value
  • Maturity (if applicable)
  • If in excess of 5% limits part gives up
  • Under the policy if all rights are given up

This system is measured in detail in our

Technical Centre –

UK bonds that fetch chargeable event gains are liable to Income Tax, but not accountable to Basic Rate Tax. Alternative, the individual investors are believed to have paid tax at basic rate on the profit available (at any situation the notional tax is not repayable).

What it is in broad terms:

  • There is no further tax on the profit for basic rate taxpayers
  • 20% tax on the profit liable for higher rate taxpayers
  • 25% tax on profit for taxpayers who are liable for additional rates

The amount liable to tax is not “grossed up” (as is the case with dividend or interest income).

Considering the fact, profits earned are normally treated as forming the highest chunk of total income, taxpayer from the lowest tax slabs can be forced into the higher tax rates, or the taxpayers who are already at higher tax slabs can be forced into additional rate.

“Top slicing relief” may assist on such events to reduce the actual tax rate that is charged by implementing a distribution mechanism.

Internal Offshore Bonds

Life companies based in jurisdictions issue internal offshore bonds, which apply no tax on the earnings and profits of the basic capitals – known as “gross roll-up”. Due to the impact of irretrievable withholding tax which may be cut from the interest and dividends of the received funds, growth may not be completely tax free.

External Offshore Bonds

Chargeable event legislation again determines the tax treatment of these policies. In broad terms:

  • 20 % tax on the profit liable for basic rate taxpayers
  • 40% tax on the profit liable for higher rate taxpayers
  • 45% tax on the profit liable for additional rate taxpayers

Wherever necessary top slicing respite is available OEIC investment probably seems to be more appropriate investment for basic rate taxpayers when CGT exemption is available in a pure tax terms. Given that OEICs must circulate available earnings, the dynamics starts to change for both higher and additional rate taxpayers. To assist you in the process of decision making, prudential offer calculators to OEICs and bonds. Additionally, sea of information is available in our technical centre that covers both facts and planning.

The Unit Trust or OEIC

Collection investment funds like Unit trusts and Open-Ended Investment Companies (OEICs) are managed. Lot of money is accumulated from huge number of investors to buy shares, bonds, property or cash as assets and other forms of investments. On shore investment that includes UK-based, OEICs and unit trusts are covered by the fund advisors.

Taxation of unit trusts and OEICs

Taxation of Unit Trusts and OEICs

Taxation management whether it is Open-Ended Investment Companies (OEICS) or unit trusts completely is determined on the combination of the fund.

The fund is categorised as a non-equity fund if more than 60% of the total find is invested in cash or fixed interest. This means whatever earning it be, all will be taxed as an interest sharing.

The fund is categorised as an equity fund if less than 60% of the total fund is capitalized in the form of cash or fixed or secured interest. This tells that whatever earning it will be it would be taxed as a dividend distribution.

Income Payment Corporation Tax

In case of non-equity funds, one can reclaim or compensate against the company’s corporation tax responsibilities if the fund manager has cut tax as 20% for the financial period. The tax on the complete interest will be due in 9 months and 1 day after the financial year end of a complete fund is selected

Through equity funds, the limited companies are not responsible to corporation tax in UK dividend income they get.

Capital gains and corporation tax

Both recognised and unrecognised gains with non-equity funds are liable to corporation tax annually. Any capital gains with equity funds are taxed during clearance. Even though the company has the advantage of indexation allowance, no yearly relief is available.

Advantages of the UK Bond

Here you will get a well explained summary of possible advantages and disadvantages of UK bonds.

Any advices can be influenced by many considerations and that includes:

  • Simplicity
  • Price
  • Access
  • Risk profile
  • Fund choice
  • Future aspirations and objectives
  • Tax

The above mentioned are a part of recommendation made for clients specifically.

Taxation of the UK Bond - Under the chargeable event legislation, single premium investment bonds are taxed, (excluding the corporate investors where loan relationship rules come into play) this concludes instead of capital gain tax (CGT) chargeable profits are measured to income tax. There is a loss of corporation tax by the bond inside the life fund. The exact rate compensated will vary within the fund but the bondholders will be considered to have payed tax at the rate of equivalent to 20% in the fund even when the rate is lower. The capital gains that occur from within the life fund are charged with 20% tax but they are profited from indexation relief. In 1998, this was removed for individuals but life funds still get benefitted from this exemption and this will continue.

Bondholder Taxation

Tax liability on encashment will be more for higher and additional rate tax payers. As a conclusion the life fund taxation already faced a higher rate (40%) taxpayer will have to pay an extra 20% on the profit and an extra rate (45%) taxpayer will pay an extra 25% on the profit.

UK Bond Wrapper Advantages

Bonds don’t produce income and hence they are non-income producing assets hence there are no yearly tax returns for individuals and trustees Funds can be swapped between bonds without helping in rising of a CGT or income tax responsibility on the investor and with no requirements of tax reporting. Swapping off and on of funds is not liable to the CGT 30-day rule so it will not help in rise of taxable events. It is recognised that profits may benefit from top deduction exemptions which can decrease or remove any higher or additional rate responsibility. Advantages of top-ups are from top-deduction from starting (for individuals only). Bonds can be allocated in the form of gifts too without giving growth to a tax charges although there could be inheritance tax (IHT) attached to it. Each year one can take 5% tax overdue allowance of the original investment for 20 years without producing instant tax obligation. The bonds can also be gifted into trust and allocated out of trust without increasing income tax or CGT burdens. To avoid expenses on events of death of the applicant(s), several lives that are guaranteed can be used at inception. Wherever testing is required by a local authority for residential maintenance, single premium investment bonds are not included normally.

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