Session 003: Calculating bond gains on exit Q&A

Q. Can you cover excess gains being ignore if surrendered before end of tax year of excess event again please or provide some reading on this?

A. See sections 4 and 5 of bond taxation planning article. The article refers to UK bonds but the same principles apply for offshore bonds.

Q. Client with no other income, takes withdrawals from an offshore bond within the 5% allowance each year for 20 years. After 20 years should they continue?

A. It is a common misconception that investment bonds should always be rebased after 20 years has passed however it depends on the circumstances of the case. Just because the tax deferred allowance rolls up at 5% p.a. for 20 years doesn’t mean that after 20 years all that tax deferred allowance will be used up. For example, if someone took 2.5% withdrawals of the investment amount each year, after 20 years, there would still be tax deferred allowance available of 50% of the amount invested.

Even where the tax deferred allowance has been used up in full, it doesn’t follow that the bond must be encashed. It might be that further withdrawals, while triggering a chargeable event, may not result in any tax due. This is relatively common where it is a UK investment bond and the policyholder is a basic rate taxpayer as the tax credit plus the ability to use top slicing might eliminate any tax due.

There are cases where is makes sense to encash the bond and reinvest. For example in order to stop large gains building up which if not dealt with, could result in an unnecessary tax liability further down the line or, where the bond value has increased and reinvesting would result in a larger tax deferred allowance going forward.

Q. Higher rate taxpayer through DB income - encashment of bonds are there any way around this or do you just pay the higher rate tax? - Onshore bond Prudential and Aviva

A. If the full bond gain sits within the higher rate tax band then some top slicing relief might be available if the policyholder has some personal savings allowance (PSA) available. The PSA for a higher rate taxpayer is £500 so in a lot of cases this has already been used up by other savings income e.g. bank interest, and may not be available for the bond gain. Even where the PSA is available it’s likely there would be higher rate tax due on the bond gain (unless its small or top sliced over many years).

It is possible to mitigate higher rate tax on bond gains sitting within higher rate by making a pension contribution. The policyholder would need relevant earnings to support a tax relievable personal contribution, but if not, as long as they were under the age of 75, they could still make a contribution of £3,600 gross which could be beneficial in dealing with a bond gain. If a relief at source contribution is made then the basic rate band is extended by the gross amount of the contribution. Broadly speaking if the basic rate band can be extended to cover the top sliced gain, higher rate tax on the gain may be avoided.

The calculations depend on the facts of the case and the interaction of the savings allowances means they can be complex. We have a Tax Relief Modeller which can be used to work out the tax due on bond gains, with or without pension contributions.  When you access the tool you will also find links to support material relating to the taxation of band gains and how tax relief on pension contributions is obtained. 

Q. With regards to having to self-assess with more than £10,000 savings income, would this include wrapper switching into ISA for example?

A. Yes.

Q. How can a client report a chargeable gain to HMRC?

A. Please refer to HMRCs HS320 help sheet for guidance.

Q. Could you repeat the point about self-assessment of gains in relating to savings income / savings allowances?

A. This is covered in the section titled “How to report a gain” in HMRCs HS320 help sheet.

Q. If a client hasn't reported historic gains on bonds, despite their being no tax liability, can they retrospectively declare to HMRC?

A. They would only need to self-assess if the gain (or their share of the gain if it’s a jointly owned bond) was more than £10,000. If their share is over £10,000 but they failed to file a return for the relevant tax year, we would recommend contacting HMRC. Late filing penalties can apply and interest may also be added.

Q. Is it still the providers responsibility to send a CEC we know the gain is over say the basic rate of tax and sent to HMRC for the client?

A. The requirements are explained in section 1.1 of HMRCs Chargeable event certificate guidance for insurers.

Q. Does the £10,000 limit for self-assessment apply to trustees?

A. No. If trustees are being assessed on a bond gain they will need to self-assess in a tax year where they have more than £500 of income and be subject to trustee rate of tax on the full gain. Bond gains are savings income so are taxed at 45% in the hands of trustees (onshore bonds receive a 20% tax credit so trustees are only required to pay 25% on the gain).

The £500 threshold is split between the number of trusts set up by the settlor subject to a minimum of £100 per trust. It should be understood that the threshold is not an exemption and any income not accounted for at the time will be accounted for and taxed further down the line. The threshold is simply a way of reducing the administrative burden on small trusts who have low levels of income or chargeable gains.

Q. Can life take 30+ days to provide CGC's?

Insurers are required to deliver Chargeable Event Certificates to HMRC before the end of the relevant 3 month period. The relevant period is whichever ends the latest out of:

• the period of 3 months following the end of the year of assessment in which the event happened or, if the policyholder is a company, the period of 3 months following the end of the financial year in which the event happened
• the period of 3 months following the end of the year (as defined in section 499) in which the event happened (if the event is a surrender or assignment of a part that is a chargeable event by virtue of section 498)

However, if the event is a death or an assignment in whole or in part, under section 552(7)(c) ICTA 88, where an insurer receives written notification of a death or assignment they must report the relevant chargeable event details to HMRC within 3 months of receiving this notification. Where this notification is received outside of the tax year in which the date of event occurs, this can cause administrative difficulties for insurers who then need to submit several extra batches of certificates, either on paper or magnetic media, to HMRC during the year in order to meet the time limits.

Q. With an offshore bond under discretionary trust, can you please explain why a minor cannot be assigned a bond segment prior to surrender? 

A. Trustees are unable to obtain a valid receipt from a minor and bond providers cannot contract with a minor which is why a deed of assignment for a minor shouldn’t be used. If the trustees want a the beneficial ownership of the bond to be held solely for a minor beneficiary then the correct route is to exercise their power of appointment and appoint the bond (or segments) to be held on bare trust for the minor. The trustees would often stay the same post the appointment but it would be possible to change trustees as well e.g. from the grandparents to the parents of the beneficiary (although a change in trustees might require a separate deed to be executed).

Appointing segments onto bare trust for the minor beneficiary will achieve the objective for gains crystallised by the trustees to be assessed against the minor beneficiary at their marginal. The only exception to this would be if the settlor(s) of the trust are the parents of the unmarried minor beneficiary in which case the parental settlement rules would apply. If these rules apply the parent(s) would be assessed on any gain above £100.

If the bond or segments are appointed on bare trust, the trustees can later assign the legal ownership to the beneficiary once they reach age 18.

Q. Ongoing adviser charges count as part of 5% withdrawals. Do they count against a repayment to settlor on initial investment with a loan trust?

A. Ongoing advice charges do reduce the tax deferred allowance applicable to a bond however, it is the trustees of a loan trust who pay for ongoing advice so the charge is not a loan repayment to the settlor.

Q. Who is the chargeable gain attributed to if a bond is held in discretionary trust, but fully surrendered in the same tax year as the death of the settlor?

A. If it’s single settlor it would be assessed against the settlor. If it was joint settlor and the other settlor died in a previous tax year, half the gain would be assessed at trustee rate. We have decision trees in section 4 of our Important information about trusts guide that you should find helpful.

Q. Is the investment manager charge not being included within the 5% allowance based on the domiciliary of the bond? Or can any bond provider offer this?

A. No, it can be offered by UK and overseas bond providers but dependant on their bond product options. Prudential International do have legacy products that offer Discretionary Fund Manager (DFM) options. As this agreement is between Prudential International and the DFM, the fee is taken from the bond as a product fee and therefore does not use tax deferred allowance. At this time, Prudential International don’t provide an option for individual adviser firms to take investment manager fees.

Q. Regarding the investment manager charge, does certain criteria have to be met to be able to apply this instead of ongoing adviser charge?

A. Yes, the fee for general advice services to the client must always come out of the tax deferred allowance. 

Q. Last week you said you would do an example of how to apply an ongoing adviser charge as a set amount based on the amount invested v fund based OAC.

A. When an investment bond is set up there is normally the option of taking ongoing advice charge based on a percentage of the fund value or of the premium invested.

If for example, you recommended a client invests £100,000 in an investment bond and took OAC based on 0.5% of the amount invested, you would receive a flat non-variable level of OAC equivalent to £500 p.a. This would not change dependent on the performance of the investment.

If on the other hand you made the same investment but elected for an OAC of 0.5% p.a. based on the fund value, the OAC received would fluctuate depending on the underlying value of the investment. This could result in more or less OAC being paid than opting for the flat rate.

It should be remembered that OAC uses up the bond’s tax deferred allowance and so taking OAC based on the value of the fund can make it harder to know when a chargeable event may occur.  If the policyholder were to take a regular withdrawals of 4.5% of the original investment p.a. and the adviser took 0.5% OAC based on the fund value, this could easily lead to the 5% tax deferred allowance being exceeded causing an excess gain. Whether or no this would cause a tax charge depends on the policyholder’s tax position and the level of excess gain.

Q. What about OCF or platform charge? do they reduce the TDA?

A. Ongoing adviser charges are essentially a withdrawal by the client to meet the cost of advice which is why they use TDA.  Platform charges don’t use TDA because it’s a product related fee.

Q. Is there a modelling tool that allows to see a what if effect on hypothetical future withdrawal scenario? 

A. We have a Bond Gain Tool which can be used to work out the chargeable gain on a withdrawal. The tool allows you to see what the gain would be by either making a atrial withdrawal, full surrender of segments, or a combination of the two. When you access the tool you will also find links to other support material on the taxation of bonds.

We also have a Tax Relief Modeller tool which can be used to work out the tax due on bond gains taking into account the policyholder’s other income and the effect of top slicing relief.  When you access the tool, you will also find links to support material relating to the taxation of band gains and how tax relief on pension contributions is obtained.

Q. Offshore bonds offer grater return than onshore?

A. With the exception of 100% return being equities, an offshore bond has the propensity of providing a higher investment return than an onshore bond due to the benefit of gross roll-up. However, it’s the net benefit after tax that’s key.

Q. I have a client who is fed up with the UK and moving to Dubai He intends to cash in his bond, with a big chargeable event - what do HMRC do in that case?

A. If the policyholder is UK resident in the tax year the chargeable event arises they will be subject to UK tax on the chargeable gain and may need to complete a UK tax return and pay any tax due.

If the policyholder is not UK resident in the tax year of the chargeable event then there is no UK tax due on the gain. There are anti-avoidance rules however, that mean where the policy is “temporarily non UK resident”, HMRC will tax them on a gain realised during their period of non-UK residence. You can find further details on these rules in section IPTM3734 of HMRCs guidance.

If the policyholder is not UK resident then they will also have to consider the tax regime of the country in which they are resident so may need to seek tax advice in the jurisdiction concerned.

Q. Can you provide some clarity on applying for wholly disproportionate gains if a bond has given rise to an artificially high gain early in the life of the bond?

A. The application process is explained in HMRCs iptm3596 guidance.

Q. What would you suggest an advice firm does if a Bond provider isn't forthcoming with Bond transaction history required for charge event gain calc?

A. If you have account manager or sales support representative with the bond provider, they might be able to help resolve the matter. If not, I would suggest submitting a formal complaint as the bond provider shouldn’t have a problem providing a transaction history.