Growth from reinvested income

So far we have only looked at the position from the standpoint of capital growth driven purely by realised capital gains. If, however, income is generated which is paid or reinvested the position is different. In reality, there are very few funds that generate no income whatsoever.

With a collective, income will, in general, be taxed on the investor whether it is paid out or reinvested. This means that UK dividend income will suffer a further income tax liability at an effective rate of 25% on the net dividend, so out of a net dividend of £800 the investor will see £600 of benefit.

With income arising to a UK insurance company in a Life fund, the income is taxed at 20% at source on savings income. With UK dividend income, the income is received with a 10% tax credit and suffers no further tax. This means that dividend income is marginally more tax efficient when received within a Life fund if the investor is a higher rate taxpayer.

For example,


Dividend income (net) £ 800
Growth in unit value £800
Tax at 20% on encashment of bond £160
Net return £640

This should be compared with £600 net benefit if the dividend were received from a collective. In this example, the taxation on income within an onshore bond is 7% more attractive. So, to the extent that investment growth is driven by reinvested dividends or fixed interest, the UK investment bond looks attractive when compared to a collective. But then it always did.

For offshore bonds (assuming no unreclaimable withholding tax), dividends will also bear no tax at fund level but there will be no tax credit on encashment. This means an offshore bond looks as attractive in the accumulation phase but the lack of tax credit harms it comparatively on encashment by a UK resident investor.





What all of this tells us is that on tax grounds, as has always been the case, it is essential to “do the numbers”, especially where there is a significant income element to the underlying investment and the investor is investing for the longer-term. Which investment wrapper is preferable on tax grounds will depend on a number of factors and it is essential that the variables are taken into account.

The proposed change to the CGT rate will make collectives look more attractive for some investors choosing to invest in funds with strong capital gains and who are likely to be higher rate taxpayers at encashment. But to conclude from this that collectives will deliver a superior tax result for all investors would not be correct. The key to giving good advice is to make decisions on a client by client basis dependant on the facts and taking account of all the variables. And, of course, tax is only one determinant on the advice given – albeit a very important one.

Other factors will contribute to this decision making process, such as:

Administrative Simplicity

As a non-income and non-capital gains producing investment, an investment bond (UK or offshore) is relatively easy to manage from a tax standpoint. There is “nothing to declare” on the tax return until a chargeable event occurs. This should be compared with the potential need to declare income and some gains realised in connection with collectives and the cost of time and/or accountancy services to finalise the tax return. The value of the simplicity that the bond delivers will be investor dependent.