OOkay, there is not any sugarcoating this: I’m writing about bond taxation, so I’ll keep it transient, if not exactly sweet.
Bond taxation is confusing and life is fleeting. So – real quick – here’s what you’ll want to know to remain on the best side of the tax investigator:
- Bonds aren’t taxed like stocks.
- Offshore bond funds aren’t subject to the identical taxation as onshore bond funds. (In other words, treatment could also be different in case your pension fund relies outside the UK.)
- Exchange traded funds (ETFs) aren’t taxed like bond funds.
The following two tables summarize the income and capital gains tax treatments and the differences between the main varieties of bond vehicles.
Further explanations could be found below.
Tax on bonds: interest
| Pension funds (OEIC, Unit Trust) |
binding ETF |
Individually gold plated |
Individually binding |
|
| Tax on interest | Income tax rate (e.g. 20%) |
Income tax rate | Income tax rate | Income tax rate |
| Interest paid gross or less taxes | Gross | Gross | Gross | Gross |
| ISA/SIPP shelter | Freed | Freed | Freed | Freed |
Note: Bond funds paid out their income gross since 2017.
Tax on bonds: capital gains
| Pension funds (OEIC, Unit Trust) |
binding ETF |
Individually gold plated |
Individually binding |
|
| Capital Gains Tax (CGT) | Payable | Payable | Freed | Payable unless it’s a professional corporate bond |
| Non-reporting fund (offshore) | CGT payable at Income tax rate |
CGT payable at Income tax rate |
n/a | n/a |
| ISA/SIPP shelter | Freed | Freed | Freed | Freed |
That’s the tax on bonds and bond funds in a nutshell.
Now let’s take a look at the small print.
Where do you have to keep your bonds and bond funds?
If your fund is greater than 60% If any amount is invested in fixed interest and money at any time throughout the accounting 12 months, its distributions shall be deemed to be interest Payments – not as dividends.
Distributions/excess reportable income will due to this fact be subject to liability Income tax at your standard rate moderately than softie dividend tax rates.
You can avoid income tax on bonds and pension funds by keeping them in your ISA/SIPP – or by not being a taxpayer.
Since 2017, pension funds registered as OEICs or unit trusts have paid out their income gross, i.e. without tax deduction. A welcome simplification.
The tax rate you pay on bond income depends upon your general income tax status.
Non-reporting bond funds may pay gross interest. Further information on non-reporting funds could be found below.
To hold a person bond in your ISA or SIPP, it have to be listed on the stock exchange or issued by a listed company.
Individual gilts are immune from capital gains tax.
However, gold plated pay Tax on capital gains.
After 2022’s big bond decline that roiled Treasury bond prices, the shortage of a capital gains tax on individual Treasury bond gains could make holding low-coupon, high-maturity-yield Treasury bonds probably the most tax-efficient option for you. Calculate fastidiously.
Offshore bond funds
If an offshore fund/ETF doesn’t have UK reporting status, capital gains are payable under Income tax rates.
That’s bad news because capital gains tax rates are much friendlier than income tax. The £6,000 tax-free capital gains allowance – which drops to £3,000 from April 6, 2024 – would count for nothing on this case. And higher tax rate taxpayers would pay 40% (income) tax on their capital gains as an alternative of 20% capital gains tax.
Make sure your offshore bond tracker states in its fact sheet that it’s a reporting fund. HMRC also publishes one List of reporting funds.
Offshore bond funds/ETFs, like equity funds, are subject to withholding tax.
If your pension fund relies within the UK, reporting status and withholding tax aren’t a problem.
Taxation of index-linked Gilt ETFs in comparison with index-linked Gilt funds
Some UK-based index-linked funds are exempt from income tax on the inflation component of interest payments.
In other words, if inflation rises 5% in a 12 months and government bonds pay an extra 1% interest, you then only pay income tax on that 1% and never the opposite 5%.
However, index-linked offshore Gilt ETFs generally charge income tax on your complete interest payment (including the inflation-based element) as they don’t benefit from the same exemption as onshore funds.
So for those who’re stocking up on an index-linked gilt fund, search for a tracker fund based within the UK. (Email the provider to make sure they supply a tax exemption for inflation-linked interest.)
Be calm,
