How the taxman treats investments

Unnecessary tax on savings
If you or your partner is a non-taxpayer, make sure you are not paying unnecessary tax on bank and savings accounts. Avoid the automatic 20 per cent tax deduction on interest by completing form R85 from your bank or product provider or reclaim it using form R40 from HMRC.

Individual Savings Accounts (ISAs)
You pay no personal Income Tax or Capital Gains Tax (CGT) on any growth in an ISA, or when you withdraw your money. You can save up to £10,680 per person in an ISA in the 2011/12 tax year. If you invest in a Stocks & Shares ISA, any dividends you receive are paid net, with a 10 per cent tax credit. The tax credit cannot be reclaimed by anyone including non taxpayers. There is no further tax liability. The impact of taxation (and any tax reliefs) depends on your individual circumstances.

Unit Trusts and Open-Ended Investment Companies (OEICs)
With a Unit Trust or OEIC your money is pooled with other investors’ money and can be invested in a range of sectors and assets such as stocks and shares, bonds or property.

Dividend income from OEICS and unit trusts invested in shares: if your fund is invested in shares, then any dividend income that is paid to you (or accumulated within the fund if it is reinvested) carries a 10 per cent tax credit.

If you are a basic rate or non taxpayer, there is no further income tax liability. Higher rate taxpayers have a total liability of 32.5 per cent on dividend income and the tax credit reduces this to 22.5 per cent, while additional rate taxpayers have a total liability of 42.5 per cent reduced to 32.5 per cent after tax credit is applied.

Interest from fixed interest funds: any interest paid out from fixed interest funds (these are funds that invest, for example, in corporate bonds and gilts, or cash) is treated differently to income from funds invested in shares. Income is paid net of 20 per cent tax. Non taxpayers can re-claim this amount, basic rate taxpayers have no further liability; higher rate taxpayers pay an additional 20 per cent, additional rate taxpayers pay 30 per cent (whether distributed or re-invested).

Capital Gains Tax (CGT): no CGT is paid on the growth in your money from the investments held within the fund, but when you sell, you may have to pay CGT. You have a personal CGT allowance that can help limit any potential tax liability.

Accumulated income: this is interest or dividend payments that are not taken but instead reinvested into your fund. Even though they are reinvested, they still count as income and are subject to the same tax rules as for dividend income and interest.

Onshore investment bonds 
Investment bonds have a different tax treatment from many other investments. This can lead to some valuable tax planning opportunities for individuals. There is no personal liability to CGT or basic rate Income Tax on proceeds from your bonds. This is because the fund itself is subject to tax, equivalent to basic rate tax.
You can withdraw up to 5 per cent each year of the amount you have paid into your bond without paying any immediate tax on it. This allowance is cumulative, so any unused part of this 5 per cent limit can be carried forward to future years (although the total cannot be greater than 100 per cent of the amount paid in).

If you are a higher or additional rate taxpayer now but know that you will become a basic rate taxpayer later (perhaps when you retire, for example), then you might consider deferring any withdrawal from the bond (in excess of the accumulated 5 per cent allowances) until that time. Whether you pay tax will depend on factors such as how much gain is realised over the 5 per cent allowance (or on full encashment) and how much other income you have in the year of encashment (the gain plus other income could take you into the higher rate tax bracket). Those with age related allowances could lose some or all of this allowance if the gain on a bond added to other income takes them over £24,000 in the 2011/12 tax year, which equates to a marginal rate of tax on ‘the age allowance trap’ element of their income chargeable at 30 per cent.

If you do this, you will not usually need to pay tax on any gains, however this will depend on your individual circumstances at that time and as such professional financial and tax advice should be sought regarding this complex area.

The taxation of life assurance investment bonds held by UK corporate investors changed from 1 April 2008. The bonds fall under different legislation and corporate investors are no longer able to withdraw 5 per cent of their investment each year and defer the tax on this until the bond ends.

Offshore investment bonds
Offshore investment bonds are similar to onshore investment bonds (above) but there is one main difference. With an onshore bond, tax is payable on gains made by the underlying investment, whereas with an offshore bond no income or capital gains tax is payable on the underlying investment. However, there may be an element of withholding tax that cannot be recovered.

The lack of tax on the underlying investment means that potentially it can grow faster than one that is taxed. Tax may, however, become payable on a chargeable event (usually on encashment or partial encashment) at a basic, higher or additional rate tax as appropriate. Remember that the value of your fund can fluctuate and you may not get back your original investment.

UK shares 
If you own shares directly in a company you may be liable to tax.

Dividends: any income (dividends) you receive from your shares carries a 10 per cent tax credit. Higher rate taxpayers have a total liability of 32.5 per cent on dividend income and the tax credit reduces this to 22.5 per cent, while 50 per cent additional rate taxpayers have a total liability of 42.5 per cent reduced to 32.5 per cent after tax credit is applied.

When you sell shares, you may be liable to CGT on any gains you might make. Current CGT rates are 18 per cent or 28 per cent for basic and higher rate tax payers respectively. You have an annual allowance and special rules apply to calculating your gains or losses.