One lesser-known CGT solution...

Mark Green, head of tax & estate planning at Legal & General, explains how investment bonds can breathe new life into capital growth.

With interest rates continuing at their all time low and income tax rates of 40% (or even 50%), income-seeking investors are finding it difficult to achieve meaningful returns and are turning their attention to those asset classes that achieve returns in the form of capital growth.

This allows the investor to use their annual capital gains tax (CGT) exemption before paying CGT at 18% or 28%. However, although investors appear to be paying a lower rate of CGT compared with income tax, they are paying CGT on the entire gain of an asset, even where the gains are purely attributable to inflation.

This problem is going to be exacerbated over time.

One possible way to mitigate this is to consider the use of an investment bond issued by a UK company. On the face of it this may not appear to be an obvious solution but the rationale will become apparent.

It is important to understand that in the original investor’s hands, an investment bond, being a life policy, is not liable to CGT.

The underlying investment returns of a life policy fund are subject only to corporation tax (CT), and not to CGT. Crucially though, when a gain is calculated, indexation relief to filter out inflationary gains is deducted before CT becomes payable.

This means that any gain arising simply as a result of inflation is not taxed. This is one of the reasons that the true rate of life fund taxation is less than the assumed rate of 20% the investor is credited with, and represents a major benefit for the investor/policyholder.

When a chargeable gain in relation to an investment bond falls to be taxed on the investor/policyholder, it is not liable to CGT but to income tax.

With an investment bond issued by a UK company, the investor/policyholder benefits from the basic rate credit. This means a basic rate taxpayer will have no further liability to income tax if, after the addition of the chargeable gain to their other taxable income, they remain a basic rate taxpayer. And for higher and additional rate taxpayers, the chargeable gain will only be subject to the higher rate (20%) or additional rate (30%) of income tax, as appropriate.

One of the unique attributes of an investment bond is that there are two ways to take withdrawals. Either taking an equal amount of money from each of the segments that make up the bond – called partial encashment - or by encashing a specific number of segments – called segment encashment.