Tony Wickenden, Financial Planning Week tip: Considerations around tax wrapper choice

The impact of the announced Growth Plan changes on the taxation (and thus potential attraction or otherwise) of UK (onshore) and international (offshore) investment bonds

The Growth Plan (AKA “mini budget”, AKA “Fiscal Event”) fulfilled many expectations in relation to tax change. It also delivered some surprises. The resulting market reaction and the very real and current impact on the currency and potential interest rates and inflation have all been very well documented.

In the context of tax change, this bulletin considers the impact of the announced Growth Plan changes on the taxation (and thus potential attraction or otherwise) of UK (onshore) and international (offshore) bonds.

So, what are the changes that could/will have an impact on decision making about where to place new and potentially existing investments. Tax is by no means the most important in that decision making, but it is a material contributor. A strategy done “tax well” will deliver some Alpha over one done just “well”. A statement of the obvious if ever there was one.

Here are the announced changes to factor into decision making:

The basic rate of tax will fall to 19% on 6 April 2023.

The additional 1.25% on dividend taxation will be removed on 6 April 2023. The dividend additional rate will also be removed. This will apply for dividends received by individuals and trusts. The highest dividend rate will be 32.5% from 6 April 2023.

The proposed abolition of the additional rate of tax (45%) from 6 April 2023 has now been reversed so the additional rate remains for individuals and trustees, for non-dividend income. Note, however, that no announcement has been made about the abolition of the additional dividend tax rate (currently 39.35%), at the time of writing. If that abolition is also reversed (as one would expect it would), the highest dividend tax rate will be 38.1% from 6 April 2023.

No changes to top slicing relief or the 5% withdrawal rules.

No changes to capital taxation (inheritance tax (IHT) and capital gains tax (CGT)) were (or have been) announced.

So, why are these particular changes material? Well….

  1. The rate of taxation charged on gains and income arising inside a UK life fund on policyholder funds is anchored to the basic rate of tax – that’s 19% from 6 April 2023 – not the 19% corporation tax rate, and its set to stay this way. It does not therefore increase, or decrease, aligned to the rate of corporation tax.
  2. With the basic rate falling to 19% from 6 April 2023, the rate of tax payable by higher rate taxpayers on chargeable gains made on UK investment bonds from 2023/24 will effectively be 21% (not the current 20%). The effective rate represents the difference between the higher rate of tax and the basic rate.
  3. A lower basic rate (19%) charge will apply to gains falling within this band made under offshore bonds. Chargeable gains made under UK bonds remain free from basic rate tax of course.
  4. The reversal of the abolition of the additional rate of tax (45%) will mean that the maximum tax rate that can be paid on a gain made under a UK bond will be 26% and 45% under an offshore bond.
  5. The removal of the 1.25 % dividend charge – from 6 April 2023 – will improve slightly the relative position of collective investments. However, it must be remembered that dividends received will not suffer tax at any level inside a UK or offshore bond at life fund level. And with a UK bond, the policyholder will also have a basic rate tax credit to set against any gain.
  6. No changes to top slicing relief or the 5% withdrawal rules (both very long standing by the way) delivers important stability in tax planning with bonds.
  7. No changes to capital taxation – that’s CGT and IHT.

So, what conclusions can we draw from all of this?

  1. The basic principles of wrapper decision making (bonds v collectives and UK bond v offshore bond) haven’t changed, but the “nuancing “(reflected in those rate changes noted above) has.
  2. As for before the changes described above take effect, each case must be decided on its own facts – with the benefit of advice. There are a number of “moving parts” to take into account.

         But, subject to all of the forgoing:

  1. To the extent that an individual can use the CGT exemption and the dividend allowance then there is no obvious tax deferment benefit to enjoy from bond investment.
  2. Once an individual has exceeded the CGT exemption and dividend allowance and especially if they are a higher rate taxpayer and can defer taking gains until they are a basic rate or non-taxpayer, then potentially material tax benefit can be secured by investing in UK or offshore bonds – as appropriate in the circumstances. Keep an eye on respective charges though before making a decision.
  3. The lowering of the basic rate (and thus the UK life fund rate on policyholder funds) will, over time, have a beneficial impact on UK life fund growth to the extent that the growth comes from other than dividend income – all other things being equal.
  4. For investors in offshore bonds, who can minimise other income in the year of encashment, they will be able to secure zero tax on build up and a potentially reduced basic rate tax on gains beyond the personal and savings allowance.
  5. Investors in UK bonds will need to factor into their encashment/withdrawal strategy that post 5 April 2023 bond gains, net of the basic rate credit, will be taxed at 21% (higher rate taxpayers) and 26% (additional rate taxpayers) and not 20% and 25% respectively.
  6. For bonds held over the long term the value of top slicing relief and potentially undrawn/unused 5% withdrawals continues to be really high.
  7. If an individual is looking to use a trust with a financial product, then considering a bond first – given its unique and powerful tax status in relation to tax deferment and potential to make a tax effective encashment – can make sense on tax grounds.
  8. And remember, assignment of a UK or offshore bond to any (adult) individual (from an individual or a trust), is entirely possible (and usually income tax and CGT free) if this fits with your client’s financial plan and will reduce the tax on final encashment by the assignee (transferee).