The Internal Taxation position of the main types of UK Investment Products.
A forgotten tax?
The rates of personal taxation (and tax reliefs) applicable to individuals who hold products such as ISA's, Unit Trusts or Personal Pensions is quite widely known, and is frequently a deciding factor when choosing to use one product rather than an alternative product.
However, a factor that is often ignored or understated is that many investment funds held within different product wrappers also suffer internal taxation within the fund itself. Like personal taxation, the rates and types of taxation applicable differ between different types of products (surprise, surprise).
As we had difficulty locating a comparison of these products, we decided to create a comparison matrix from scratch.
As you will see, there are some differences between Life Insurance Funds (accessible via Investment Bonds), Unit Trust & OEIC Funds, Investment Trusts and Personal Pensions. This 'hidden' layer of taxation will impact the returns that you receive and/or the amount of capital growth within the specific investment fund.
In general, Life Funds suffer the heaviest taxation, while Offshore Bonds and Personal Pensions suffer the least internal taxation. However, does this mean that you should invest all your spare cash in Offshore Bonds and Personal Pensions? Not quite, as this ignores the personal tax liabilities that could be applicable to a holder of one of these plans. In reality, even an onshore bond can be a suitable investment for an individual in the correct circumstances.
| UK Investment Bond | Offshore Investment Bond | Investment Trust | Unit Trust | OEIC | ISA | Personal Pension | |
| [Taxation of:] | |||||||
| UK Dividends | Received net of 10% tax credit. No further tax payable | Received net of 10% tax credit. No further tax payable | Received net of 10% tax credit. No further tax payable | Received net of 10% tax credit. No further tax payable | Received net of 10% tax credit. No further tax payable | Received net of 10% tax credit. No further tax payable. Tax credit no longer reclaimable | Received net of 10% tax credit. No further tax payable. Tax credit no longer reclaimable |
| Non-UK Dividends | Usually received net of local withholding taxes. Corporation Tax payable at 20% on grossed up dividend. Some credit may be given for tax already paid if double taxation agreement in place. | Usually received net of local withholding taxes. No further tax payable | Usually received net of local withholding taxes. Corporation Tax payable of up to 30% on grossed up dividend. Some credit may be given for tax already paid if double taxation agreement in place. (1) | Usually received net of local withholding taxes. Corporation Tax payable at 20% on grossed up dividend. Some credit may be given for tax already paid if double taxation agreement in place. | Usually received net of local withholding taxes. Corporation Tax payable at 20% on grossed up dividend. Some credit may be given for tax already paid if double taxation agreement in place. | Usually received net of local withholding taxes. No further tax payable. No reclaim allowed. | Usually received net of local withholding taxes. No further tax payable |
| Other Income | Corporation Tax payable at 20% on interest and Bond income, and 22% otherwise | No tax payable | Corporation tax payable at up to 30% (1) | Corporation tax payable at 20% | Corporation tax payable at 20% | No tax payable. Reclaim permitted where tax deduced at source on UK income. | No tax payable |
| Capital Gains | Can be reduced using indexation allowance | No tax payable (usually) | No tax payable | No tax payable | No tax payable | No tax payable | No tax payable |
| Tax payable in directly held assets | Corporation Tax payable at 20% on gains | No tax payable (usually) | No tax payable | No tax payable | No tax payable | No tax payable | No tax payable |
| Tax payable where assets are held in other collective investment schemes | Deemed annual disposal of assets but gain / loss spread over seven year period. | No tax payable (usually) | No tax payable | No tax payable | No tax payable | No tax payable | No tax payable |
| Personal Tax liabilities applicable to holders of these investments | |||||||
| UK Investment Bond | Offshore Investment Bond | Investment Trust | Unit Trust | OEIC | ISA | Personal Pension | |
| Income Tax | |||||||
| Nil Tax-Payer | No income tax payable, as long as the 'top-sliced' gain does not push the investor into the higher-rate tax band. | No tax payable, as long as gain does not push the taxpayer into any tax bands. | No tax payable on dividends. No refund of tax credit. | No tax payable on dividends. No refund of tax credit. Possible tax refund if the UT pays interest (from cash and bonds funds), not dividends | No tax payable on dividends. No refund of tax credit. Possible tax refund if the OEIC pays interest (from cash and bonds funds), not dividends | No tax payable on dividends or interest payments. No refund of tax credit. | 25% of fund can be taken tax-free at retirement age. No further tax on income secured from the residual pension funds. |
| 20% Tax-Payer | No income tax payable, as long as the 'top-sliced' gain does not push the investor into the higher-rate tax band. | Gain taxable at 20% | No tax payable on dividends. | No tax payable on dividends. No refund of tax credit. No further tax to pay if the UT pays interest (from cash and bonds funds), not dividends | No tax payable on dividends. No refund of tax credit. No further tax to pay if the OEIC pays interest (from cash and bonds funds), not dividends | No tax payable on dividends or interest payments. | 25% of fund can be taken tax-free at retirement age. 20% Income Tax on income secured from the residual pension funds. |
| 40% Tax-Payer | Gain assessed at 20% (40% less 20% tax taken within the fund). Where a gain pushes a basic-rate taxpayer into the higher band, the rate will be pro-rated between 0% and 20% | Gain taxable at 40% | The grossed up dividend is assessed at the special higher rate at 32.5%, with a 10% tax-credit | The grossed up dividend is assessed at the special higher rate at 32.5%, with a 10% tax-credit. Interest payments (from cash and bond funds) are assessed at 40%, with a 20% tax credit. | The grossed up dividend is assessed at the special higher rate at 32.5%, with a 10% tax-credit. Interest payments (from cash and bond funds) are assessed at 40%, with a 20% tax credit. | No tax payable on dividends or interest payments. | 25% of fund can be taken tax-free at retirement age. Up to 40% Income Tax on income secured from the residual pension funds. |
| 45% Tax-Payer | Gain assessed at 25% (45% less 20% tax taken within the fund). Where a gain pushes a basic-rate taxpayer into the additional rate band, the rate will be pro-rated between 0% and 30% | Gain taxable at 45% | The grossed up dividend is assessed at the special higher rate at 42.5%, with a 10% tax-credit | The grossed up dividend is assessed at the special higher rate at 42.5%, with a 10% tax-credit. Interest payments (from cash and bond funds) are assessed at 45%, with a 20% tax credit. | The grossed up dividend is assessed at the special higher rate at 42.5%, with a 10% tax-credit. Interest payments (from cash and bond funds) are assessed at 45%, with a 20% tax credit. | No tax payable on dividends or interest payments. | 25% of fund can be taken tax-free at retirement age. Up to 45% Income Tax on income secured from the residual pension funds. |
(1) With effect from 1 September 2009, investment trusts that invest in interest bearing assets will have the option of reclaiming corporation tax they pay and passing on the tax liability to the shareholder.
Under the previous tax rules, investment trusts were liable to corporation tax on any interest income that they receive. This has not changed, but optional tax rules were introduced that allow an investment trust that invests in interest bearing assets to receive a tax deduction for any interest distributions made. This will effectively remove any corporation tax liability that would otherwise arise on distributed interest type income.
Where an interest distribution is made by an investment trust it will be treated in the hands of the shareholder as if it was a payment of yearly interest. Further details can be found in BN27 available on HMRC website.
Pensioners entitled to age allowance should be aware that dividend or income payments from Unit Trusts / OEICS and Investment Trusts is added on top of your regular income in order to calculate whether the income limit is exceeded. 5% withdrawals from Investment Bonds are not taken into account when calculating age allowance income limits, but any chargeable events resulting from Investment Bonds are assessed against the limits.
Capital Gains Tax
From the above products, only Unit Trusts / OEICS / Investment Trusts are liable to a Capital Gains Tax charge in the hands of individuals.
From the 2008/9 tax-year, a major overhaul of the Capital Gains Tax regime came into effect. Instead of the complicated system of indexation and taper-relief (depending on when you purchased the asset), there a flat rate on all Capital Gains, irrespective of the length of time that you owned the asset. Basic Rate taxpayers are subject to CGT at the rate of 18%, while the rate for Higher Rate taxpayers is 24%
However, beware that is you make a very large gain, this can push a basic-rate taxpayer into the higher-rate bracket. Effectively part of the gain would be taxed at 18%, while the remainder would be taxed at 24%.
The aim is to simplify the previously complicated regime, and whilst on the whole this is largely a good thing, there will be winners and losers. This depends upon factors such your current highest marginal tax rate and the length of time you have held assets (i.e. whether you have taken advantage of taper relief, or trade assets on a regular basis).
The main changes involved:
- The withdrawal of taper relief (there is no retrospective exemption for assets held before 6 April 2008)
- The withdrawal of indexation allowance (this only affects assets that were acquired before 6 April 1998)
- The removal of the ‘kink test’ (this rule stipulated that assets held on 31 March 1982 were valued for CGT purposes at their market value as of that date.)
- Streamlining of the share identification rules. From 6 April 2008 all shares of the same class in the same company will be treated as forming one single asset (known as a ‘share pool’), regardless of when they were originally purchased or acquired.
However, the same day rules and “bed and breakfasting” rules remain unchanged, and shares will be identified under those rules before they are identified with shares in the share pool.
The Annual Exemption remains in place. The first £3,000 of an individual's net gains realised during the tax year is free of CGT. (For Trustees, the Annual Exemption is £1,500 ). Any gains above this amount will face the flat rate CGT charge of 18%.
However, from 23 June 2010, instead of one flat rate, there is now two band of Capital Gains Tax charged at basic and higher rates (or three if you take into account the rate charged to trustees and representatives of deceased persons).
Instead of the old system of charging at the highest marginal rate of income tax and using taper relief, we know have the following bands:
- A flat rate of 18% for any chargeable gains that fall within the basic rate band of income tax.
- A flat rate of 24% for any chargeable gains that fall within the higher rate band of income tax.
- A flat rate of 24% for any chargeable gains realised by trustees and representatives of deceased persons.
For most basic rate taxpayers who make small gains (such as by selling shares), the basic rate will most likely apply. However, things get more complicated if large gains are realised, i.e. by the sale of a second home. This is due to a quirk in the tax rules that state that income and total capital gains are added together to determine the relevant tax rate. This could drag a basic rate taxpayer into the higher rate bracket.
If a large gain is realised by a basic rate taxpayer, the total gain is added to taxable income. The portion of the gain that falls below the higher rate tax threshold will be taxed at 18%, while the portion of the gain that falls above the higher rate tax threshold will be taxed at 24%. Effectively this has the effect of top-slicing the gain, and the effective rate of CGT will be in the range of 18% - 24%.
If you have any comments about the accuracy of this table, please let us know.
NOTE: This document is intended to provide a brief overview of the subject. It should not be read as a recommendation to use any particular product, as it does not take into account individual circumstances and attitudes.