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When and how chargeable gains are taxed

You may have clients holding UK and international bonds, both of which are subject to income tax under the chargeable events regime.

With an international bond, investors benefit from growth that is largely free of tax as no UK tax is imposed on the income and gains in the underlying funds. However, under a UK bond the life company pays corporation tax on the income and gains in the underlying funds.

For the tax year 2018/19, an individual may be entitled to a personal allowance of £11,850, £5,000 starting rate savings band, which is taxed at 0%, and a personal savings allowance (PSA) (£1,000 basic rate, £500 higher rate or £0 additional rate). In all the examples below, I have assumed that Sally has no other income.

Chargeable gains from both international and UK bonds are treated as “savings income”. However, as chargeable gains from a UK bond carry a 20% tax credit they are treated as ‘the highest part of the individual’s total income’, so can only take advantage of the PSA. Whereas, international bond gains can take advantage of both the PSA and the starting rate savings band.

Let’s consider Sally, who holds both UK and international bonds and in the tax year 2018/19, has non-savings income of £11,850.

In August 2018 she decides to surrender her UK bond, producing a chargeable gain of £10,000. The £11,850 personal allowance (2018/19) must first be used against her non-savings income, so there is no tax to pay on her non-savings income. The chargeable gain then sits on top and as the gain is deemed to have paid basic rate income tax Sally has no further tax liability. Sally cannot benefit from the starting rate savings band or the personal savings allowance due to the UK bond carrying the 20% tax credit.

If Sally had surrendered an international bond her non-savings income would be covered by the personal allowance. Then £5,000 of the chargeable gain would be taxed at 0% plus another £1,000 being covered by the PSA. The remaining £4,000 would be taxed at 20%, giving Sally a tax liability of £800.

If we now look at the situation where Sally has non-savings income of £20,000, with a UK bond when the chargeable gain is added to her income she remains a basic rate taxpayer so there is no further tax liability. However, the situation is slightly different with an international bond. 

The £5,000 starting rate savings band is restricted by the non-savings income so that none of the band is available where the non-savings income is above the personal allowance plus the £5,000. So, as Sally’s non-savings income is over £16,850 the starting rate savings band is lost but the PSA will be available. As Sally is a basic rate taxpayer both before and after the chargeable gain has been added to her non-savings income, £1,000 of the gain will be taxed at 0% (PSA), with the remainder being taxed at 20%. Giving Sally a tax liability of £1,800.

Now let’s consider the situation where top-slicing relief will be of benefit.

Sally has non-savings income of £43,350 and has held the bond for 2 complete years, giving a top-sliced gain of £5,000 (£10,000/2). Even though HMRC allow the gain to be spread over the complete number of years the bond has been in force, to calculate the tax liability, they will treat the whole gain as income in the tax year in which the event occurred. This means that Sally will be treated as a higher rate taxpayer which means the PSA is reduced to £500.

Firstly, if we look at the UK bond, as it is deemed to have paid basic rate income tax £3,000 of the gain is covered by the basic rate tax band. Next the PSA is placed against the first slice of the higher rate meaning that £500 is taxed at 0%. This leaves £1,500 of the top-sliced gain being chargeable at the higher rate of 20%. Additional tax payable on the top- slice is therefore £1,500 x 20% = £300. Giving Sally a tax liability of £600 against the chargeable gain.

If we now consider the international bond, as the chargeable gain does not carry a 20% tax credit the first £500 of the top- sliced gain is taxed at 0%. Then the next £2,500 (£46,350 – (£43,350 + £500)) is taxed at 20%, giving a basic rate tax liability of £500. Leaving £2,000 of the top-sliced gain which is chargeable at the higher rate of 40%, giving a higher rate tax liability of £800. This means that Sally has a total tax liability of £2,600 against the chargeable gain – (£500 x 2) + (£800 x 2).

Knowing the order in which international and UK chargeable gains are taxed, together with the interaction of the PSA, will ensure that the best exit strategy is determined for your clients.

We say

International bond gains are treated as savings income and can therefore benefit from both the personal allowance and the £5,000 starting rate band for savings.

UK bond gains carry a 20% tax credit which is non-reclaimable, so, if your client is a non-taxpayer, consider international bonds to utilise the allowances.

Remember that if the gain, when added to your client’s income, takes them into another tax bracket, the gain can be top sliced.

For more information, please contact your dedicated account manager.

Kim Jarvis is a technical manager at Canada Life. She has worked in the life industry arena for over 20 years, with experience in trusts and their taxation, product development, the impact of new legislation on the industry and delivering training. She is an affiliate of the Society of Trusts and Estate Practitioners and a Chartered Insurer.